Price+Elasticity+of+Demand+(PED)

** Ped **** measures the **** responsiveness of demand **** for a product following ****__ a change in its own price __****. **
 * Edexcel learning Outcomes: **

** The formula for calculating the co-efficient of elasticity of demand is: ** **// Percentage change in quantity demanded divided by the percentage change in price //**

** Since changes in price and quantity nearly always move in opposite directions, economists usually do not bother to put in the minus sign. We are concerned with the value of elasticity of demand. **

** Understanding values for price elasticity of demand **
 * ** If Ped = 0 **** then demand is said to be **** perfectly inelastic **** . This means that demand does not change at all when the price changes – the demand curve will be vertical **
 * ** If Ped is between 0 and 1 **** (i.e. the percentage change in demand from A to B is smaller than the percentage change in price), then **** demand is inelastic **** . Producers know that the change in demand will be proportionately smaller than the percentage change in price **
 * ** If Ped = 1 **** (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to **** unit elastic **** . A 15% rise in price would lead to a 15% contraction in demand leaving total spending by the same at each price level. **
 * ** If Ped > 1 ****, then demand responds more than proportionately to a change in price i.e. **** demand is elastic **** . For example a 20% increase in the price of a good might lead to a 30% drop in demand. The price elasticity of demand for this price change is –1.5 **

** What Determines Price Elasticity of Demand? **


 * ** The number of close substitutes for a good / uniqueness of the product **** – the more close substitutes in the market, the more elastic is the demand for a product because consumers can more easily switch their demand if the price of one product changes **** relative **** to others in the market. The huge range of package holiday tours and destinations make this a highly competitive market in terms of pricing – many holiday makers are price sensitive **
 * ** The % of a consumer’s income allocated to spending on the good **** – goods and services that take up a high proportion of a household’s income will tend to have a more elastic demand than products where large price changes makes little or no difference to someone’s ability to purchase the product. **
 * ** The time period allowed following a price change **** – demand tends to be more price elastic, the longer that we allow consumers to respond to a price change by varying their purchasing decisions. In the short run, the demand may be inelastic, because it takes time for consumers both to notice and then to respond to price fluctuations **
 * ** Whether the good is subject to habitual consumption **** – when this occurs, the consumer becomes much less sensitive to the price of the good in question. Examples such as cigarettes and alcohol and other drugs come into this category. **



=Student tasks: Discuss: " Pepsi Price elastic or inelastic?" ; "Luxury cars price elastic or inelastic?" . Remember think about the determinants of demand!=

** Elasticity of demand and total revenue for a producer ** ** The relationship between price elasticity of demand and a firm’s total revenue is a very important one. The diagrams below show demand curves with different price elasticity and the effect of a change in the market price. **

** When demand is inelastic – a rise in price leads to a rise in total revenue – for example a 20% rise in price might cause demand to contract by only 5% (Ped = -0.25) **

** When demand is elastic – a fall in price leads to a rise in total revenue - for example a 10% fall in price might cause demand to expand by only 25% (Ped = +2.5) ** ** The table below gives a simple example of the relationships between market prices; quantity demanded and total revenue for a supplier. As price falls, the total revenue initially increases, in our example the maximum revenue occurs at a price of £12 per unit when 520 units are sold giving total revenue of £6240. **
 * ** Price ** ||  ** Quantity **  ||  ** Total Revenue **  ||  ** Total revenue increases or decreases? **  ||
 * ** £ per unit ** ||  ** Units **  ||  ** £s **  ||   ||
 * ** 20 ** ||  ** 200 **  ||  ** 4000 **  ||   ||
 * ** 18 ** ||  ** 280 **  ||  ** 5040 **  ||   ||
 * ** 16 ** ||  ** 360 **  ||  ** 5760 **  ||   ||
 * ** 14 ** ||  ** 440 **  ||  ** 6160 **  ||   ||
 * ** 12 ** ||  ** 520 **  ||  ** 6240 **  ||   ||
 * ** 10 ** ||  ** 600 **  ||  ** 6000 **  ||   ||
 * ** 8 ** ||  ** 680 **  ||  ** 5440 **  ||   ||
 * ** 6 ** ||  ** 760 **  ||  ** 4560 **  ||   ||

** Consider the price elasticity of demand of a price change from £20 per unit to £18 per unit. The % change in demand is 40% following a 10% change in price – giving an elasticity of demand of -4 (i.e. highly elastic). In this situation when demand is price elastic, a fall in price leads to higher total consumer spending / producer revenue ** ** Consider a price change further down the estimated demand curve – from £10 per unit to £8 per unit. The % change in demand = 13.3% following a 20% fall in price – giving a co-efficient of elasticity of – 0.665 (i.e. inelastic). A fall in price when demand is price inelastic leads to a reduction in total revenue. **


 * ** Change in the market ** || ** What happens to total revenue? ** ||
 * ** Ped is inelastic and a firm raises its price. ** ||  ||
 * ** Ped is elastic and a firm lowers its price. ** ||  ||
 * ** Ped is elastic and a firm raises price. ** ||  ||
 * ** Ped is -1.5 and the firm raises price by 4% ** ||  ||
 * ** Ped is -0.4 and the firm raises price by 30% ** ||  ||
 * ** Ped is -0.2 and the firm lowers price by 20% ** ||  ||
 * ** Ped is -4.0 and the firm lowers price by 15% ** ||  ||

** So in summary what would you do if PED was elastic ** ** What would you do if price was inelastic? **

** Now as revision to check your understanding of PED watch the following video. This is also useful if you have missed any lessons. **

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Further Elasticity notes

PED TEST