Price elasticity of demand (PED)

Question 1

PED

Answer 1

Measures the responsiveness of quantity demanded to changes in price

Question 2

Calculation

Answer 2

PED = % Change in Q.D. ÷ % Changes in price

• Note:
  > The law of demand tells us that when price increases, demand will fall, and that when price decreases, demand will rise
  > Therefore, the sign ( + or - ) on the top will always be different to the sign on the bottom
  > Therefore PED will always be a minus but you can just ignore the sign.

Question 3

What determines PED

Answer 3

• The number of close substitutes
  > The more close substitutes there are in the market, the more elastic is demand because consumers find it easier to switch e.g. fast food burgers
• The cost of switching between products
  > There are many significant costs involved in switching. In this case, demand tends to be relatively inelastic. E.g. mobile phone service providers may insist on a 12 month contract
• The degree of necessity or whether the good is a luxury
  > Necessitates tend to have an inelastic demand where as luxuries tend to have more elastic demand
• The proportion of consumers income allocated to spending in the good
  > Products that take up a high % of income will tend to have a more elastic demand
• The time period allowed following a price change
  > Demand tends to be more price elastic, the longer that consumers have to respond to a price change. They may search for a cheaper substitutes and switch their spending
• Peak and off peak demand
  > Demand tends to be price inelastic at peak times and more elastic at off peak times - e.g. trains
• Whether the good is subject to habitual consumption
  > Consumers become less sensitive to the price of the good or they buy something out of habit

Question 4

Using PED

Answer 4

• Revenue = Price x Quantity sold
• Knowing whether the demand for a product is elastic or inelastic will help an entrepreneur to decide whether or not to increase or decrease price - if maximising revenue is there objective

Question 5

Values making it elastic or inelastic

Answer 5

• 1.0 or above is elastic
• 0.1 and below is inelastic