Notes on Price Elasticity of Demand (PED)

Basics of Demand

• Law of Demand: When the price increases, quantity demanded decreases. When the price decreases, quantity demanded increases.
• Importance: Understanding how much demand changes with price is crucial.

Price Elasticity of Demand (PED)

• Definition: Measures the responsiveness of quantity demanded given a change in price.
• Equation:
  PED = (Percentage Change in Quantity Demanded) / (Percentage Change in Price)
  • Remember: Quantity before Price ("Queue before you pee").

Percentage Change Calculation

• Formula:
  Percentage Change = (Difference / Original Number) x 100

Understanding PED Values

• PED will always be negative due to the law of demand:
  • Price increase leads to a negative quantity change.
  • Price decrease leads to a negative quantity change.
• Interpreting PED Values:
  • PED > 1: Demand is price elastic (greater proportionate change in quantity demanded than price).
  • PED < 1: Demand is price inelastic (less proportionate change in quantity demanded than price).
  • PED = 0: Perfectly price inelastic (quantity demanded does not change with price).
  • PED = ∞: Perfectly price elastic (quantity demanded changes infinitely with any price change).
  • PED = 1: Unit price elastic.

Example Calculations

1. Cigarettes:

   • Price increase from £4 to £5:
     • Percentage Change in Price: 25%
     • Quantity demanded decrease from 150 to 135: 10% decrease.
     • PED = -0.5 (Inelastic).

2. Sofa:

   • Price decrease from £1,000 to £800:
     • Percentage Change in Price: 20%
     • Quantity demanded increase from 2,000 to 3,800: 90% increase.
     • PED = -4.5 (Elastic).

Demand Curves

• Inelastic Demand: Steep demand curve (quantity changes less than price).
• Elastic Demand: Shallow demand curve (quantity changes more than price).
• Perfectly Inelastic: Vertical line.
• Perfectly Elastic: Horizontal line.

Factors Affecting PED (SPLAT)

• S: Substitutes
  • More substitutes = More price elastic.
  • Fewer substitutes = More price inelastic.
• P: Percentage of Income
  • Larger percentage = More price elastic; smaller percentage = More price inelastic.
• L: Luxury vs Necessity
  • Luxuries = More price elastic; necessities = More price inelastic.
• A: Addictiveness
  • Addictive goods = More price inelastic.
• T: Time Period
  • Short run = More price inelastic; long run = More price elastic.

Conclusion

• Understanding PED is crucial for businesses in determining pricing strategies and anticipating changes in demand.
• Next topic: Link between PED and Total Revenue.