Price Elasticity of Demand (PED)

• PED measures the responsiveness of a change in demand, after a change in price.

• PED = % change in Q.D.                       
                          % change in price

  PED = change in Q                *      ___Price__   
                  Q                                        Change in P

 

• If price increase by 10% and demand for CDs fell by 20% then PED = -20/10 = -2
• If price increase from £50 to £55 and PED was 0.5 . How much did quantity demanded fall?
• 0.5 = % change in QD
• Therefore % QD = -5

Elastic Demand

Definition: Demand is elastic if a change in price leads to a bigger % change in demand; therefore the PED will therefore be greater than 1.

Goods which are elastic, tend to have some or all of the following characteristics.

1. They are luxury goods
2. They are expensive and a big % of income e.g. sports cars and holidays
3. Goods with many substitutes and a very competitive market. E.g. if Simsbury’s put up the price of its bread there are many alternatives, so people would be price sensitive
4. Bought frequently

 

Inelastic Demand

These are goods where a change in price leads to a smaller % change in demand; therefore PED <1 e.g. 0.5

• Inelastic demand PED <1 - Perfectly inelastic PED =0

Goods which are inelastic tend to have some or all of the following features:

1. They have few or no close substitutes, e.g. petrol, cigarettes.
2. They are necessities
3. They are addictive
4. They cost a small % of income or are bought infrequently

 

• In the short term demand is usually more inelastic because it takes time to find alternatives
• If the price of chocolate increased demand would be inelastic because there are no alternatives, however if the price of mars increased there are close substitutes in the form of other chocolate therefore demand will be more elastic.

 

Using Knowledge of Elasticity

1. If demand is inelastic then increasing the price can lead to an increase in revenue. This is why OPEC try to increase the price of oil.

Graph showing increase in Revenue following increase in price

 

2. If demand is elastic, firms would be unlikely to increase revenue as this could lead to a fall in revenue. Instead they could try advertising to increase brand loyalty and make demand more inelastic

3. Price Discrimination. Some people pay higher prices for tickets for trains because there demand is more inelastic.

Essays and Revision Notes on Supply and Demand

• Demand
• Supply
• Market Equilibrium
• Price Mechanism Long Term
• Demand and Utility
• Consumer and Producer Surplus

Elasticity

• Price Elasticity of Demand
• Income Elasticity of Demand
• Cross Elasticity of Demand
• Price Elasticity of Supply