business

• Price elasticity of demand (PED)


  Measures the responsiveness, sensitivity of demand to changes in price
• How PED works

  1. Formula: Percentage change in quantity demanded / Percentage change in price

  2. Quantity demanded is on top, price is on bottom
• Elastic PED


  • PED coefficient is greater than 1 (e.g. -4)
  • Demand is very sensitive to price changes
• Inelastic PED


  • PED coefficient is less than 1 (e.g. -0.2)
  • Demand is not very sensitive to price changes
• Elastic PED

  Increasing prices reduces revenue, decreasing prices increases revenue
• Inelastic PED


  Increasing prices increases revenue, decreasing prices reduces revenue
• Usefulness of PED

  • Allows businesses to predict impact of price changes on quantity demanded and sales
  • Helps with staffing, inventory, cash flow and financial forecasting
  • Important for international businesses subject to exchange rate changes
• Factors making demand more inelastic


  • Strong brand loyalty
  • Few rivals/monopoly
  • Product is cheap compared to consumer income
  • Someone else is paying
  • Little time to consider purchase
• Difficulties in calculating accurate PED
• Income elasticity of demand


  Measures the responsiveness of demand to changes in income
• Formula for income elasticity of demand


  Percentage change in quantity demanded / Percentage change in income
• Positive income elasticity of demand


  • Incomes increased by 20%, quantity demanded increased by 40% - coefficient of +2
• Positive income elasticity of demand


  Indicates a normal good or luxury good
• Negative income elasticity of demand


  Indicates an inferior good
• If income elasticity of demand is known


  Can forecast changes in quantity demanded based on expected changes in income
• If income elasticity of demand is positive and greater than 1


  Indicates a luxury good, so quantity demanded will fall more than proportionately to a fall in income
• If income elasticity of demand is known and a recession is expected


  Business can prepare by reducing inventory, workforce, and securing financing