Price Elasticity of Demand (PED) (AQA A Level Economics)

• The law of demand states that when there is an increase in price, there will be a fall in the quantity demanded
  • Economists are interested by how much the quantity demanded will fall

• Price elasticity of demand reveals how responsive the change in quantity demanded is to a change in price
  • The responsiveness is different for different types of products

Calculation of PED

• PED can be calculated using the following formula
  
  

• To calculate a % change, use the following formula
  
  

PED Classifications

• Knowledge of PED is important to firms seeking to maximise their revenue
• Sales revenue will be maximised 
  • If their product is price inelastic in demand, they should raise their prices
  • If their product is price elastic in demand, then they should lower their prices
    
• This rule is used when firms choose to use [popover id="F_vUGukEe4aWRck1" label="price discrimination"] to maximise their revenue
  • They lower their prices for elastic sections of their market e.g. off peak train travel
  • They increase prices for inelastic sections of their market e.g. peak hour train trave
• The benefits of this rule can be illustrated using a demand curve
  • A shallow curve represents a price-elastic product
  • A steep curve represents a price inelastic product

Diagram: Elastic Demand Curve 

A small decrease in price from P₁ → P₂ causes a large increase in quantity demanded from Q₁ → Q₂

Diagram analysis

• When a good/service is price elastic in demand, there is a greater than proportional increase in the quantity demanded to a decrease in price
  • A small decrease in price leads to a larger increase in QD
• TR is higher once the price has been decreased
  • 

Diagram: Inelastic Demand Curve 

A large increase in price from P₁ → P₂ causes a small decrease in quantity demanded from Q₁ → Q₂

Diagram analysis

• When a good/service is price inelastic in demand, there is a smaller than proportional decrease in the quantity demanded to an increase in price
  • A large increase in price leads to a smaller decrease in QD
• TR is higher once the price has been increased
  • 
    

• Some products are more responsive to changes in prices than other products
• The factors that determine the responsiveness are called the determinants of PED and include:
  • Availability of substitutes: good availability of substitutes results in a higher value of PED (relatively elastic)
  • Addictiveness of the product: addictiveness turns products into necessities, resulting in a low value of PED (relatively inelastic)
  • Price of product as a proportion of income: the lower the proportion of income the price represents, the lower the PED value will be. Consumers are less responsive to price changes on cheap products (relatively inelastic)
  • Time period: In the short term, consumers are less responsive to price increases, resulting in a low value of PED (relatively inelastic). Over a longer period of time, consumers may feel the price increase more and will then look for substitutes, resulting in a higher value of PED (relatively elastic)