Price Elasticity of Demand (PED) (Edexcel A Level Business)

An Introduction to Price Elasticity of Demand (PED)

• When there is an increase in price, there will be a fall in the quantity demanded and when there is a fall in price there will be an increase in the quantity demanded

• The question businesses are interested in is, by how much will the quantity demand change?

• The Price elasticity of demand helps us to calculate how responsive the change in quantity demanded will be to a change in price

  • The responsiveness is different for different types of products

Calculation of PED

• The PED value is always negative

• PED can be calculated using the following formula
  

• To calculate a % change, use the following formula

Interpretation of PED Numerical Values

• The numerical value of PED indicates the responsiveness of a change in quantity demanded to a change in price

• PED will always be negative due to the inverse relationship between price and quantity

  • If the price goes up, the quantity demanded goes down

  • If the price goes down, the quantity demanded goes up

Interpretation of PED Values

Factors Influencing the Price Elasticity of Demand

The factors which determine if a product is more price elastic or price inelastic in demand

Brand Loyalty

• The aim of advertising and marketing expenditure by a business is to shift the demand curve to the right and make the demand more price inelastic

  • E.g. Coke consumers are more brand loyal to Coke and refuse to buy Pepsi, even though their taste is very similar

Availability of substitutes

• PED will be more price inelastic (lower) for goods that have fewer substitutes

  • E.g. Petrol has fewer substitutes and is more price inelastic whereas chocolate bars have more substitutes and are more price elastic

The proportion of income taken up by the product

• The smaller the proportion of income we spend on a product the more price inelastic the demand will be

  • E.g. A small amount of income is spent on salt and so the demand for salt will be more price inelastic whereas buying a new car takes up a bigger proportion of consumer income and so is more price elastic in demand

Luxury or Necessity

• Necessities are required as part of consumers' daily needs and are therefore more price inelastic in demand

  • E.g. Bread, milk, petrol, gas and electricity might be considered to be necessities

• Luxuries are not essential and are therefore more price elastic in demand

  • E.g. Smoked salmon, Nike Air Jordans, and foreign holidays might be considered to be luxuries

Time

• The longer the time period under consideration the more price elastic the demand for a good or service is likely to be (consumers have more time to search for substitutes)

• The shorter the time period under consideration the more price inelastic the demand for a good or service is likely to be

  • E.g. If the price of petrol increases making driving more expensive, there is little that consumers can do in the short term. However, they may switch to alternatives such as public transport or bicycles in the long term

The Significance of PED to Businesses

• If businesses can determine the price elasticity of demand for their products, they can adjust their pricing strategy to maximise their revenue

• If demand for their products is relatively price inelastic (PED < -1), raising the price will lead to an increase in total revenue. However, lowering the price will lead to a fall in total revenue

  • Price skimming strategies are best employed for products that are price inelastic in demand

• If demand for their products is relatively price elastic (PED > -1), raising the price will lead to a fall in total revenue. However, lowering the price will lead to a rise in total revenue

  • Competitive pricing strategies are best employed for products that are price inelastic in demand

The Relationship Between Price Elasticity of Demand and Total Revenue

Price Elastic Demand

• PED is greater than 1

• An increase in selling price reduces the total amount of revenue generated from sales

• A reduction in selling price increases the total amount of revenue generated from sales

Price Inelastic Demand

• PED is between 0 and 1

• An increase in selling price increases the total amount of revenue generated from sales

• A reduction in selling price reduces the total amount of revenue generated from sales