Price elasticity of demand (PED)

Definition Measures the responsiveness of demand for a good or service after a change on the price of the good or service.

The PED of a good or service is calculated as follows:- PED formula The PED of a good or service is calculated as follows:- Percentage change in the quantity demanded of the good or service Percentage change in the price of the good or service Remember, you need to q before you p! For normal goods, this will give a negative(-) figure in line with the laws of demand and a downward sloping demand curve

Factors that determine the PED for a good or service 1.The availability of substitutes. Where a good or service has few substitutes, the PED for that good or service is likely to be low (inelastic). This means a rise in the price of the good or service will see a proportionally smaller change (contraction) in demand for that good or service (an inelastic response). . petrol

Factors that determine the PED for a good or service 2. The time taken to switch to substitutes. Where it takes time to switch to a substitute following a price rise, the PED for that good or service is likely to be low (inelastic). This means a rise in the price of the good or service will see a proportionally smaller change (contraction) in demand for that good or service (an inelastic response). petrol

Factors that determine the PED for a good or service 3. Whether the good or service is a luxury or necessity. Where the good or service is a necessity, the PED for that good or service is likely to be low (inelastic). This means a rise in the price of the luxury good or service will see a proportionally smaller change (contraction) in demand for that luxury (an inelastic response). petrol

Factors that determine the PED for a good or service 4. The proportion of income spent on the good or service. Where the good or service occupies only a small percentage of consumer incomes, the PED for that good or service is likely to be low (inelastic). This means a rise in the price of the good or service will see a proportionally smaller change (contraction) in demand for that good or service (an inelastic response). petrol?

PED Description e.g. < -1 Inelastic - 0.6 -1 Unitary > -1 PED calculations PED Description e.g. < -1 Inelastic - 0.6 -1 Unitary > -1 Elastic -1.3

Example 1 The following are price and corresponding demand figures for Soneji’s Super Sandwiches. P1 = £2.00 QD1 = 1,000 units P1 = £2.20 QD1 = 950 units

Example 1 Soneji’s Super Sandwiches may have an inelastic PED (-0.5) because

Example 2 The following are price and corresponding demand figures for Soneji’s Super Socks . P1 = £2.00 QD1 = 1,000 units P1 = £2.20 QD1 = 800 units

Example 2 Soneji’s Super Socks may have an elastic PED (- 2) because

Should Pedro’s Fish Bar raise their prices? Demand Total revenue P1 = £20 D = 500 units P2 = £24 D= 300 units Change in revenue PED

Should Pedro’s Fish Bar raise their prices? By increasing the price of their fish, they lose 200 customers who previously paid £20 per kilo. They lose £4,000 in revenue They however, keep 300 customers who are now paying an extra £4 . They gain an extra £1,200 in revenue. The difference between the two is -£2,800. This price change was NOT in the business’ interest as it resulted in a fall in total revenue. p contraction in demand 24 +£4x300 =£1,200 20 -£20x200 =£4,000 d Qd 300 500

Should Pedro’s Fish Bar raise their prices? Pedro should not have increased his prices due to the likely fall in total revenue. He should have known he had an elastic PED because

Should Price’s ferries raise their prices? Demand Total revenue P1 = £10 D = 200 units P2 = £12 D= 180 units Change in revenue PED

Should Price’s Ferries raise their prices? By increasing the ferry price, they lose 20 customers who previously paid £10 per day. They lose £200 in revenue They however, keep 180 customers who are now paying an extra £2 . They gain an extra £360 in revenue. The difference between the two is +£160. This price change WAS in the business’ interest as it resulted in a rise in total revenue. p Extension in demand 12 +£2x180 =£360 10 -£10x20 =£200 d Qd 180 200

Should Price’s Ferries raise their prices? Price were able to increase their prices and raise their total revenue. They have an inelastic PED because

Exam style question Over the past 35 years, successive governments have increased the tax duty on tobacco product. Explain the likely impact on government tax revenues when the tax duty on tobacco products is increased. (15 marks)