Price Elasticity of Demand

Introduction

• Measures the responsiveness of demand after a change in price.
• Formula: Percentage change in quantity demanded divided by the percentage change in price.
  • Changes in price and quantity usually move in opposite directions, so the minus sign is often omitted.

Coefficients of Elasticity

• PED = 0: Perfectly inelastic; demand doesn't change with price changes.
  • Demand curve is vertical.
• 0 < PED < 1: Inelastic demand; demand is relatively unresponsive to price changes.
• PED = 1: Unitary elastic; percentage change in demand equals percentage change in price.
  • Total spending remains the same at each price level.
• PED > 1: Price elastic; demand responds more than proportionately to a price change.
  • Example: A 10% price increase leads to a 30% demand drop (coefficient = 3).

Factors Influencing Elasticity

1. Number of Close Substitutes: More substitutes make demand more elastic.
2. Price Relative to Income: High-income percentage products have more elastic demand.
3. Cost of Switching: High switching costs make demand inelastic.
4. Brand Loyalty: Strong brand loyalty makes demand inelastic.
5. Degree of Necessity vs. Luxury:
   • Necessities: Inelastic demand.
   • Luxuries: More elastic demand.
6. Breadth of Definition: Broader categories like petrol are inelastic, specific brands can be elastic.

Elasticity and Total Revenue

• Total Revenue = Price per unit × Quantity
• Elastic Demand: A price cut increases total revenue.
• Inelastic Demand: A price cut decreases total revenue.

Demand Curve Examples

• Vertical Demand Curve:
  • Coefficient of elasticity = 0; demand doesn't change with price.
• Elastic Demand Curve:
  • A price cut increases total revenue due to higher change in quantity demanded than price.
• Unitary Elastic Demand Curve:
  • Price changes do not affect total revenue.

Elasticity Variance Along a Demand Curve

• Elasticity changes as you move down a linear demand curve.
  • Higher up, demand is more elastic; further down, it becomes inelastic.

Importance of Elasticity for Producers

• Helps understand the relationship between price changes and total revenue.
• Price Volatility: Important in markets with low elasticity.
• Government Taxes: Determines how much tax can be passed to consumers.
• Price Discrimination: Charging different prices based on elasticity.
  • Examples: Peak vs. off-peak pricing, household vs. industrial pricing.
  • Dynamic Pricing: Seen in companies like Uber to maximize revenue.

Evaluation Points

1. Data Accuracy: Elasticity estimates may be based on incomplete data.
2. Regional and Temporal Variation: Elasticity varies by region and time.
3. Product Range Variation: Different products within a range can have different elasticities.

Conclusion

• This topic covers many aspects of price elasticity of demand.
• Future videos will explore this topic further in microeconomics education.