Price Elasticity Of Demand

Price Elasticity of Demand is a numerical measure of the responsiveness of

demand to a change in its price.

The formula used to calculate (PED) is:

Q1 = Old Quantity
Q2 = New Quantity
P1 = Old Price
P2 = New Price

If the answer using the above formula is less than 1 than the product has price
inelastic demand
however, if the answer is greater than 1 than the product has price elastic

Price Elastic Demand: When demand changes by a greater percentage than the
changes in price.
Price Inelastic Demand: When demand changes by a smaller percentage than
the changes in price.

Revenue Maximization by Using Price Elasticity Of Demand:

Revenue: Total reward of producing goods and services.

Formula:

 Price/unit × Quantity produced /demanded

 Total cost + Total profit

The above diagrams show that:

If demand is inelastic, producers must charge high prices in order to maximize
revenue.
If demand is elastic, producers must charge low price in order to maximize
revenue.

Degrees of Price Elasticity Of Demand

Factors Affecting Price Elasticity of Demand: (SPLANT)

 Substitutes- If a product has many close substitutes, it is likely to have

elastic demand. A rise in price will cause consumers to switch to the
cheaper substitute causing a fall in quantity demanded. If there are no
close substitutes available demand will be inelastic.

 Proportion of Income Spent – If a product takes a large proportion of

income, the product will have elastic demand. If a product takes a small
proportion of income, demand will be inelastic.

 Luxuries and Necessities – Luxury products have elastic demand eg.

Cars, jewellery. Necessities have inelastic demand as people will not cut
back on their use if price rises. Eg salt.

 Addictive- If the product is an addictive which means it is habit forming,

eg. Cigarettes, coffee they will have inelastic demand.

 Narrowly Defined- If a product is narrowly defined, it will have many

substitutes and demand will be elastic. On the other hand, products which
are broadly defined have inelastic demand.
  Time Period- If the consumer has more time to buy the product, demand
will be elastic as consumers can postpone their purchase to buy at lower
price. If consumers have less time to purchase the product, the want has
to be satisfied urgently, demand will be inelastic.
 Urgency of wants- Demand is inelastic when goods are urgently needed
whereas demand is elastic when there is no urgency of wants, cosumers
have time to buy the product
 Income level- Elasticity of demand for any commodity is generally
inelastic for high income groups compared to low income groups. This
occurs as rich people are not influenced much by changes in the price of
goods, as compared to the poor, whose demand for goods will be highly
elastic.


Summary of Factors affecting PED

Availability of Substitutes:
Substitutes more available PED will be elastic

Less substitutes available PED will be in elastic

Proportion of Income Spent:

Small proportion (e.g. salt) PED will be inelastic

Large proportion (e.g. car) PED will be elastic

Nature of Product:
Need (e.g. bread) PED will be inelastic

Luxuries (e.g. car) PED will be elastic

Addictive / Habit forming:

Cigarettes are addictive thus it will have inelastic PED.

Fashion and Trend:

In fashion PED will be elastic

Out of fashion PED will be inelastic