Price Elasticity of Demand (PED)

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• Measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus

• Depends on what %Δ you want, use price for price, and QD for QD
• Elasticity declines along demand curve as we move towards quantity axis

Elasticities

• When price elasticity is between $0$ and $-1$, demand is price inelastic*
• When price elasticity is between $-1$ and $-\infty$, demand is price elastic
• When price elasticity is $-1$, demand is unit price elastic
• When DD is price elastic, the slope of the DD curve is gentler
• When DD is price inelastic, the slope of the DD curve is steeper
• Price Elastic:** Price change results in a more than proportionate change in quantity demanded
• Price Inelastic:** Price change results in a less than proportionate change in quantity demanded
• Unit Price Elastic: Price change results in a proportionate change in quantity demanded

Factors that Affect PED for a Good

1. Number and closeness of substitutes in the same price range
2. Time period
3. Proportion of income consumers spend on a good
4. Degree of necessity of the good to the consumers
5. Habit of the consumer

Number and Closeness of Substitutes in the Same Price Range

• The longer the number of substitutes (in the same price range), the higher the PED, and vice versa

Time Period

• The longer the time period, the higher the PED
• More scope for the discovery of new substitutes
• More receptive to new products
• Availability of substitutes

Proportion of Income Consumers Spend on a Good: Lower

• The lower the proportion of income spent on a good, the lower the PED
• Only a small proportion of income (won’t affect PED)
• If price increases, quantity demanded will decrease less than proportionately
• Less responsive to price changes, no incentive to look for substitutes
• Demand is price inelastic

Proportion of Income Consumers Spend on a Good: Higher

• The higher the proportion of income spent on the good, the higher the PED
• Very large proportion of income
• If price increases, quantity demanded will decrease more than proportionately
• Very responsive to price changes
• Demand is price elastic

Degree of Necessity of the Good to the Consumers: Higher

• The higher the degree of necessity, the lower the PED
• Essential to satisfy needs
• If price increases, quantity demanded will decreases less that proportionately
• Less responsive to price changes
• Demand is price inelastic

Degree of Necessity of the Good to the Consumers: Lower

• The lower the degree of necessity, the higher the PED
• Luxury items are not essential to satisfy needs
• If price increases, quantity demanded will decrease more than proportionately
• Sensitive to price change
• Demand is price elastic

Habit of the Consumer

• If the goods are consumed out of habit, an increase in price leads to a less than proportionate fall in quantity demanded
• Demand is price inelastic

Total Revenue and PED

• Why is a knowledge of PED useful to firms?
  • Allows firms to adjust price to maximise profit

$Profit=TotalRevenue-TotalLoss$

$TotalRevenue=Price\times Quantit{y}_{traded}$

• When the demand for a good is price elastic, an increase in price results in a decrease in total revenue for the firm/producer
  • Therefore, when the demand for a good is price elastic, the firm/producer should decrease the price of the good so that total revenue increases
• When the demand for a good is price inelastic, a decrease in price results in a decrease in total revenue for the firm/producer
  • Therefore, when the demand for a good is price inelastic, the firm/producer should increase the price of the good so that total revenue increases