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.