Price Elasticity of Demand (PED)
Introduction to PED
PED=% change in quantity demanded / % change in price
Price Elasticity of Demand (PED) is a measure of how responsive demand is to a change in price.
If PED is greater than 1, the good is price elastic. If PED is smaller than 1, the good is price inelastic. If PED is equal to 1, the good has unit elasticity.
If PED is equal to zero, the good is perfectly inelastic.
N.B. To classify negative PEDs, use the modulus of the value with the rules above (i.e. ignore the negative sign whilst you classify the PED)
PED along a demand curve
On a linear demand curve, elasticity decreases as the price falls and the quantity demanded increases:
- When price is high, a movement of one unit is a small % change in price.
- When demand is low, a movement of one unit is a high % change in quantity PED is elastic.
- When price is low, a movement of one unit is a high % change in price.
- When demand is high, a movement of one unit is a low % change in price. PED is inelastic.
- When price is medium, a movement of one unit is a medium % change
- When demand is medium, a movement of one unit is a medium % change There is Unit Elasticity.
Free A Level Economics Study Buddy
PED and Total Revenue
Revenue = Quantity Sold x Price
The area made by the demand curve is equal to revenue. You can clearly see that the area of the blue rectangle is greater than the area of the purple and green triangles. Therefore we can see that revenue is maximised at unit elasticity.
The maximum revenue for a firm will be at unit elasticity.
- When the price is elastic, firms can decrease prices, which will lead to a greater % rise in demand. This increases revenue.
- When the price is inelastic, firms can increase prices, which will lead to a smaller % fall in demand. This increases revenue.
Therefore, as long as price is moving towards the mid-point of the demand curve (unit elasticity), revenue will increase.
Factors affecting PES
Availability of Substitutes
If a good has many substitutes, it is price elastic because if price changes, consumers switch back and forth between substitutes.
The more narrowly defined a good is, the more substitutes it has. For example, Mars, a type of chocolate, has many substitutes such as Snickers and Dairy Milk. However, chocolate as a whole is a more broad good, and therefore tends to have fewer substitutes, and is therefore less price elastic.
Luxury and Necessity goods
Luxury goods have an elastic demand.
Necessity goods have an inelastic demand.
Proportion of Income spent on good
If a high % of income is spent on a good (e.g. a car), a change in price will have a large effect on the consumer, so the good will be price elastic.
If a low % of income is spent on a good (e.g. a newspaper), a change in price will have a small effect on the consumer, so the good will be price inelastic.
Time Period
In the short run, consumers may not respond to price changes, so the good will be price inelastic in the short term.
In the long run, consumers may change spending habits and lifestyle to save money, so the good will be price elastic in the long term.
For example, if petrol prices rise, consumers will most likely continue to buy the same amount. However, in the long term they may buy smaller cars or invest in a bike to reduce their need for petrol.
Brand Image
Goods with a strong brand image, such as Coca Cola, tend to be price inelastic because consumers are willing to pay more for these products as opposed to other substitutes, such as Tesco Cola.
Habitual Consumption & Addictive Goods
Goods which are bought on a regular basis, such as a magazine, tend to be price inelastic because consumers are in a habit of consuming them so continue to do so, regardless of a price change.
Most smokers and alcoholics will continue to purchase cigarettes and alcohol due to addiction.
Secure an A* with Award-Winning Tutors
A-Level Economics Online Tuition
Learn More£29-£35ph
→ What is price elasticity of demand?
Price elasticity of demand is a measure of the responsiveness of the quantity demanded of a product or service to changes in its price. It helps to understand how sensitive consumers are to changes in price.
→ How is price elasticity of demand calculated?
Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price.
→ What does it mean if the price elasticity of demand is greater than one?
If the price elasticity of demand is greater than one, then the demand for the product is considered elastic. This means that a small change in price results in a relatively large change in the quantity demanded.
→ What does it mean if the price elasticity of demand is less than one?
If the price elasticity of demand is less than one, then the demand for the product is considered inelastic. This means that a change in price results in a relatively smaller change in the quantity demanded.
→ What factors affect price elasticity of demand?
Factors that affect price elasticity of demand include the availability of substitutes, the necessity of the product, the proportion of income spent on the product, and the time period under consideration.
→ Why is price elasticity of demand important for businesses?
Understanding price elasticity of demand is important for businesses because it helps them to determine the optimal price point for their products or services. A thorough understanding of price elasticity of demand can help businesses to increase revenue and profits.
→ How can price elasticity of demand be used by governments?
Governments can use price elasticity of demand to make decisions about taxation and regulation. For example, if a product has an inelastic demand, a tax on it will generate more revenue for the government, without causing a significant decline in demand.
→ What are some real-world examples of price elasticity of demand?
Some real-world examples of price elasticity of demand include gasoline prices, prescription drugs, and luxury goods. Gasoline prices tend to be inelastic in the short term because consumers need to purchase gasoline regardless of the price. In contrast, luxury goods tend to be elastic because consumers have a wide range of options to choose from, and can choose to purchase a substitute product if the price of a luxury good increases.
→ How can I use my knowledge of price elasticity of demand to succeed in my A-Level Economics exam?
Understanding price elasticity of demand is a fundamental concept in A-Level Economics, and it is important to be able to apply this concept to real-world scenarios. Be sure to practice calculating price elasticity of demand and understand how changes in factors such as income and availability of substitutes can affect the demand for a product or service.
