Price Elasticity of Demand (PED)

• Price elasticity of demand-reveals how responsive the change in quantity demanded is to a change in price. The responsiveness is different for different types of products.
• The law of demand states that as prices rise, consumers will buy less
• Calculation of Price elasticity of Demand- %change in quantity demanded / % change in price. Always remember, you queue before you pee
• Calculation of percentage change- (new value - old value) / old value x 100
• PED equals 0 (PED=0)- Demand is perfectly inelastic meaning there is no change in quantity demanded regardless to change in price. Could suggest that the product has no substitute.

  Diagram is like :

  
• PED greater than 1 (PED>1) - demand is elastic meaning that consumers are responsive to change in price. The %QD is greater than %P (e.g. luxury goods)

  
• PED less than 1 (PED<1)- demand is inelastic, so consumers are unresponsive to a change in price (e.g. fuel).

  
• PED equals 1 (PED=1)- Demand is unitary elastic, so %change in QD is exactly equal to % change in price

  
• PED equals to Infinity (PED=∞)- Demand is perfectly elastic so at price P, consumers will buy any quantity which is available. The demand exists only at one price, so if the firm increase its price, consumers will switch to substitute goods, so QD drops to zero.

  
• Determinants of PED- They are SPLAT:

  • Availiability of substitutes
  • Addictiveness of the product
  • Price of product as a proportion of income
  • Time Period
  • Necessity/luxury
• Availability of substitutes- Amount and closeness of substitutes. The greater the number of substitutes, the higher the value of PED. More substitutes lead to greater price elastic, while fewer goods lead to price elastic
• Addictiveness of the product- If addicted, then consumer has no choice but to pay the price. So, they have little or no ability to reduce consumption when prices rise. This leads to low PED values. However, if not addicted, then there are many alternatives, leading to high PED values.
• Time period- Short term vs long run. In short run, people do not have time to find alternative products. But in long run, they can easily find substitutes. Hence, short run results in lower value of PED and long run is higher value of PED
• Price of product as a proportion of income- When the price of good is small compared with total income, it means that people can afford to consume more of this good even though their income falls. Therefore, PED is lower. On the other hand, when the price of good is large compared with total income, it means that people cannot afford to consume much of this good even though their income rises. Therefore, PED is higher.
• Necessitiness/Luxury- Necessities are things we need to survive such as food, water etc. Luxuries are things we want rather than need. People tend to spend less on luxuries during recessionary periods. Thus, necessities have lower PED and luxury items have higher PED
• Total Revenue- IN order to maximise revenue, firms should increase the price of products that are price inelastic in demand and decrease prices on product that are elastic in demand
• Merit goods- Goods or services that are beneficial to society (e.g. healthcare)
• Demerit goods- A good or service that causes harm to society (e.g. cigarettes, alcohol)
• Primary Commodity- Raw material that is used in making of a good (e.g. beans). PED for primary commodities are lower than that of manufactured goods because primary commodities is usually price inelastic