A LevelBusinessEdexcelRevision Notes1. Marketing & People1.2 MarketPrice Elasticity of Demand (PED)

Price Elasticity of Demand (PED) (Edexcel A Level Business): Revision Note

Exam code: 9BS0

Mark Collins

Written by: Mark Collins

Reviewed by: Steve Vorster

Updated on

An introduction to price elasticity of demand

  • When there is an increase in price, there will be a fall in the quantity demanded (QD), and when there is a fall in price, there will be an increase in the QD

  • The question businesses are interested in is "By how much will the QD change?"

  • The price elasticity of demand (PED) helps us to calculate how responsive the change in QD will be to a change in price

    • The responsiveness is different for different types of products

Calculation of PED

  • The PED value is always negative

  • PED can be calculated using the following formula:

text PED =  end text fraction numerator percent sign space change space in space quantity space demanded over denominator percent sign space change space in space price end fraction space equals space fraction numerator percent sign triangle space in thin space QD over denominator percent sign triangle in space straight P end fraction 

  • To calculate a % change, use the following formula:

percent sign space Change space equals space fraction numerator new space value space minus space old space value over denominator old space value end fraction space cross times space 100 

Worked Example

The PED for popcorn at the cinema is –0.8. The current price of a box of popcorn is £5. Using the data, calculate the percentage change in QD following a £1 increase in the price of a box of popcorn. You are advised to show your work.

[4]

Step 1: State the PED formula:

text PED  end text space equals space fraction numerator percent sign space change space in thin space demand over denominator percent sign space change space in space price end fraction  [1]

Step 2: Calculate the percentage change in price:

equals space fraction numerator £ 6 space minus space £ 5 over denominator £ 5 end fraction space cross times space 100 space equals space 20 percent sign space [1]

Step 3: Insert the data you have been given into the formula:

negative 0.8 space equals space fraction numerator straight x over denominator 20 percent sign end fraction [1]

Step 4: Rearrange and solve for x:

x space equals space minus 0.8 space cross times space 20 x space equals space minus 16 percent sign [1]

Examiner Tips and Tricks

Remember, if the price decreases, QD increases, and if the price increases, QD decreases. In this case, price increases. Therefore, QD must fall.

Interpretation of PED numerical values

  • The numerical value of PED indicates the responsiveness of a change in QD to a change in price

  • PED will always be negative due to the inverse relationship between price and quantity

    • If the price goes up, the QD goes down

    • If the price goes down, the QD goes up

Interpretation of PED values

Numerical value 

Type of good

Explanation

>1

Elastic

  • Examples include luxury products such as cars, smart watches, foreign holidays, cinema visits, jewellery and branded goods

  • Demand is more responsive to a change in price

  • The %∆ in QD is more than proportional to the %∆ in P

Between

0 and 1

Inelastic

  • Examples include necessities such as bread, milk, eggs, potatoes, fuel, rent and toothpaste

  • Addictive products such as cigarettes and sugary foods

  • Demand is less responsive to a change in price

  • The %∆ in QD is less than proportional to the %∆ in P

Examiner Tips and Tricks

Students often confuse the negative sign in the answer to PED questions. Do not assume that the negative is mathematical, such that an elasticity of –1 is smaller than –0.3. It is larger (more price elastic).

The PED will always be negative, indicating the inverse relationship between price and QD (i.e. when the price increases, QD decreases, and when the price decreases, QD increases).

When interpreting the value of PED, do not say that "the product is elastic or inelastic"; it is better to say that "demand for the product is price elastic or price inelastic".

Factors influencing the PED

Diagram illustrating factors affecting Price Elasticity of Demand (PED): brand loyalty, substitutes, income spent, time, and luxury versus necessity.
The factors that determine whether the demand for a product is more price elastic or price inelastic

Brand loyalty

  • The aim of advertising and marketing expenditure by a business is to shift the demand curve to the right and make the demand more price inelastic

    • For example, Coke consumers are more brand loyal to Coca-Cola and refuse to buy Pepsi, even though their taste is very similar

Availability of substitutes

  • PED will be more price inelastic (lower) for goods that have fewer substitutes

    • For example, petrol has fewer substitutes and is more price inelastic, whereas chocolate bars have more substitutes and are more price elastic

The proportion of income taken up by the product

  • The smaller the proportion of income we spend on a product, the more price inelastic the demand will be

    • For example, a small amount of income is spent on salt, so the demand for salt will be more price inelastic. However, buying a new car takes up a bigger proportion of consumer income, so the PED is higher

Luxury or necessity

  • Necessities are required as part of consumers' daily needs, and therefore, demand for them is more price inelastic

    • For example, bread, milk, petrol, gas and electricity might be considered necessities

  • Luxuries are not essential, and therefore, demand for them is more price elastic

    • For example, smoked salmon, Nike Air Jordans and foreign holidays might be considered luxuries

Time

  • The longer the time period under consideration, the more price elastic the demand for a good or service is likely to be (consumers have more time to search for substitutes)

  • The shorter the time period under consideration, the more price inelastic the demand for a good or service is likely to be

    • For example, if the price of petrol increases, making driving more expensive, there is little that consumers can do in the short term. However, they may switch to alternatives such as public transport or bicycles in the long term

The significance of PED to businesses

  • If businesses can determine the PED for their products, they can adjust their pricing strategy to maximise their revenue

  • If demand for their products is relatively price inelastic (PED <-1), raising the price will lead to an increase in total revenue. However, lowering the price will lead to a fall in total revenue

    • Price skimming strategies are best employed for products that are price inelastic in demand

  • If demand for their products is relatively price elastic (PED >-1), raising the price will lead to a fall in total revenue. However, lowering the price will lead to a rise in total revenue

    • Competitive pricing strategies are best employed for products that are price elastic in demand

The relationship between PED and total revenue

Price elastic demand

2-7-1 calculation and determination of PED. Relatively elastic.
Price elastic demand

  • PED is greater than 1

  • An increase in the selling price reduces the total amount of revenue generated from sales

  • A reduction in the selling price increases the total amount of revenue generated from sales

Price inelastic demand

Graph showing a demand curve (D1). Price decreases from P2 to P1, causing quantity to increase from Q2 to Q1. Axes labelled Price (£) and Quantity. The graph shows price inelastic demand.
Price inelastic demand

  • PED is between 0 and 1

  • An increase in the selling price increases the total amount of revenue generated from sales

  • A reduction in the selling price reduces the total amount of revenue generated from sales

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    Mark Collins

    Author: Mark Collins

    Expertise: Business Content Creator

    Mark has taught Business and Economics for over 25 years in the UK, Sri Lanka and Thailand. He has an MA from UCL and was a research assistant at the Institute of Education. He enjoys creating learning resources for students and has co-authored several teaching guides. Mark has been an examiner and principal examiner for various exam boards and has a mission to demystify the examination process for students. When not teaching Mark plays guitar, harmonica, ukulele and is currently teaching himself piano. He is a firm believer in Lifelong Learning.

    Steve Vorster

    Reviewer: Steve Vorster

    Expertise: Economics & Business Subject Lead

    Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.