PRICE ELASTICITY OF DEMAND

Price Elasticity of Demand (PED) Price Elasticity of demand (PED) measures the extent to which the quantity demanded changes when the price of the product changes. The formula : %change in quantity demanded PED= % change in price

Calculating PED E.g. The demand rises from 200 to 240 as a result of price falling from $10 to $9. Calculate the PED? %change in quantity demanded PED= % change in price

O The %change in demand : change in demand x 100 Original quantity demanded x 100 = 20% 200 The %Change in demand

O The %change in price : change in price x 100 Original price -$ x 100 = -10% $10 The %Change in price

PED Result %change in quantity demanded PED = % change in price 20% PED = = %

O According to the law of demand, higher demand prices are related to smaller quantities demanded. As such, the numerator and denominator of this formula always have opposite signs--if one is positive, the other is negative. If the demand price increases and the percentage change in price is positive, then the quantity demanded decreases and the percentage change in quantity demanded is negative. When calculated, the price elasticity of demand, therefore, is always negative.

O However, it is often convenient to ignore the negative sign when evaluating the relative response of quantity demanded to price. For example, quantity demanded is very responsive to price if a 10 percent increase in price induces a 50 percent decrease in quantity demanded. This generates a large "negative number," which is actually a small "value." To avoid the possible confusion over a big number being a small value, the negative value of the price elasticity of demand is generally ignored and focus is placed on the absolute magnitude of the number itself.

Factor affecting elasticity of demand O The number of close substitutes – the more close substitutes there are in the market, the more elastic is demand because consumers find it easy to switch O The cost of switching between products – there may be costs involved in switching. In this case, demand tends to be inelastic. For example, mobile phone service providers may insist on a12 month contract.

O The degree of necessity or whether the good is a luxury – necessities tend to have an inelastic demand whereas luxuries tend to have a more elastic demand. O The proportion of a consumer’s income allocated to spending on the good – products that take up a high % of income will have a more elastic demand O The time period allowed following a price change – demand is more price elastic, the longer that consumers have to respond to a price change. They have more time to search for cheaper substitutes and switch their spending.

O Whether the good is subject to habitual consumption – consumers become less sensitive to the price of the good of they buy something out of habit (it has become the default choice). O Peak and off-peak demand - demand is price inelastic at peak times and more elastic at off-peak times – this is particularly the case for transport services. O The breadth of definition of a good or service – if a good is broadly defined, i.e. the demand for petrol or meat, demand is often inelastic. But specific brands of petrol or beef are likely to be more elastic following a price change.

when the price elasticity of demand is O greater than 1, demand is elastic: consumer purchases respond a lot to a price change O equal to 1, demand is unit elastic O less than 1, demand is inelastic: consumers do not respond much to a change in price Other degree of elasticity : -Perfectly elastic : PED is infinity -Perfectly inelastic : PED is zero -Unit Elasticity of demand : PED is One

End of Presentation