Price Elasticity of Demand

Price Elasticity of Demand

Definition

  • Price Elasticity of Demand (PED) is a measure of how much the quantity demanded of a good or service changes with a change in its price.
  • It is a key concept in the field of economics and critical in understanding consumer behaviour within financial markets.

Calculating PED

  • PED is calculated by dividing the percentage change in quantity demanded of a good or service by the percentage change in its price.

Elastic Demand

  • When the PED is more than 1, demand is said to be elastic.
  • This means that quantity demanded changes more than the price.
  • For products with elastic demand, a decrease in price will result in an increase in total revenue, and an increase in price will result in a decrease in total revenue.

Inelastic Demand

  • When the PED is less than 1, demand is said to be inelastic.
  • In this case, quantity demanded changes less than the price.
  • For inelastic goods, an increase in price leads to an increase in total revenue, and a decrease in price leads to a decrease in total revenue.

Factors Influencing PED

  • Availability of substitutes: The more substitutes a good or service has, the more elastic its demand tends to be.
  • Essentiality: Products or services considered necessities typically have inelastic demand.
  • Time period: Over the long run, demand for a good or service tends to be more elastic because consumers have had sufficient time to find alternatives.
  • Percentage of income: Products or services that take up a large percentage of a consumer’s income tend to have more elastic demand.

Implications in Marketing Strategies

  • Understanding how price changes affect demand for a product can guide businesses in setting prices to maximise profit.
  • If demand is elastic, businesses might focus on competitive pricing strategies.
  • If demand is inelastic, businesses can afford to adjust prices within a wider range with less impact on demand, potentially increasing profit margins.
  • A business should also take into account how these changes could influence its competitors’ strategies, as well as the overall market dynamics.