Price Elasticity of Demand (PED)

Definition

• Price Elasticity of Demand measures how responsive the quantity demanded of a good is to a change in its price.
• Formula:
  • PED = (Percentage Change in Quantity Demanded) / (Percentage Change in Price)
  • Typically, the negative sign is ignored, focusing on the coefficient of elasticity.

Coefficients of Elasticity

• PED = 0: Perfectly inelastic demand (vertical demand curve).
• 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).
• PED > 1: Elastic demand (demand responds more than proportionately to a change in price).

Factors Affecting Price Elasticity

1. Number of Close Substitutes: More substitutes lead to more elastic demand.
2. Proportion of Income: Higher income proportion leads to more elastic demand.
3. Cost of Switching: High switching costs lead to inelastic demand.
4. Brand Loyalty and Habitual Consumption: Strong loyalty leads to inelastic demand.
5. Necessity vs. Luxury: Necessities have inelastic demand, luxuries have elastic demand.
6. Breadth of Definition: Demand for broad categories (e.g., petrol) is inelastic, while specific brands are more elastic.

Elasticity and Total Revenue

• Total Revenue = Price per Unit × Quantity
• Elastic Demand: Price decrease leads to an increase in total revenue.
• Inelastic Demand: Price decrease leads to a decrease in total revenue.

Examples

• Price reduction from £20 to £18 increases demand by 50 units, raising total revenue by £500 (PED = 2.5).
• Further price reduction can show varying impacts on total revenue depending on elasticity.

Demand Curves

• Inelastic Demand Curve: Coefficient less than 1, revenue increases with price increase.
• Elastic Demand Curve: Coefficient greater than 1, revenue increases with price decrease.
• Vertical Demand Curve: Coefficient = 0, demand does not change with price.
• Perfectly Elastic Demand Curve: Coefficient = infinity, only one price at which all is sold.
• Unitary Elastic Demand Curve: Revenue remains constant with price changes.

Variability Along Demand Curve

• Elasticity varies even along a straight-line demand curve.
• Movement down the curve can change PED from elastic to inelastic.

Applications of Price Elasticity

• Business Strategy: Firms can adjust prices to maximize revenue based on elasticity.
• Taxation: Ability to pass taxes to consumers depends on demand elasticity.
• Price Discrimination: Different prices charged based on consumers’ elasticity, e.g., Uber's surge pricing.

Evaluation Points

1. Data Accuracy: Elasticity is often estimated due to incomplete data.
2. Regional and Temporal Variation: Elasticity varies by region and time period.
3. Product Range Variation: Different products within a range can have different elasticities.

These notes cover the fundamental concepts and applications of price elasticity of demand, providing key insights into how it influences economic decisions and business strategies.