-ECONOMICSPRICE ELASTICITY OF DEMAND (PED)
PED measures the degree of responsiveness of quantity demanded when the price of the product changes.
In other words, it measures by how much quantity demanded changes when there is a change in the price
of a product.
PED is given as follows:
The sign of PED is always negative because of the inverse relationship between price and quantity
demanded.
Types of Price elasticity of demand (PED)
1) Price elastic demand
A product or service has a price elastic demand when a small proportionate change in
price leads to a big proportionate change in quantity demanded. In other words, quantity
demanded of the product is very responsive to a change in its price. Generally, it applies
for luxury goods such as diamonds, amongst others. For e.g ; if price falls by 10%, the
quantity demanded rises by 50%. The coefficient of PED is always greater than one.
2) Price inelastic demand
A product has a price inelastic demand when a big proportionate change in price leads to a
small proportionate change in quantity demanded. In other words, quantity demanded of the
product is not much responsive to changes in its price. Generally, it applies for basic
necessities such as bread, rice amongst others and the coefficient of PED is less than one. Its
diagram is given as follows;
3) Unitary Elastic Demand
A product has unitary elastic demand when a given proportionate change in price leads to the
same proportionate change in quantity demanded. For e.g if the price of the product falls by
10% quantity demanded rises equally by 10%. The coefficient of PED is equal to one. Its
diagram is given as follows:
4) Perfectly elastic demand
A product has perfectly elastic demand if its quantity demanded varies or changes when price
remains fixed. The coefficient of PED is infinite. Its diagram is given as follows:
5) Perfectly inelastic demand
A product has a perfectly inelastic demand if the quantity demanded of the product remains
fixed or unchanged following a change in price. The coefficient of PED is equal to 0. Its
diagram is given as follows:
DETERMINANTS OF PED
1) Nature of product/ degree of necessities
Generally, luxury products have a price elastic demand because such goods are high-priced
(expensive) so that any change in price will lead to a big changed in quantity demanded. In fact,
the demand for luxury products ( e.g diamond necklace) is price elastic as these are not
considered as necessities for most households.
On the other hands, basic necessities such as food, fuel, medicines, housing, transport, amongst
others will have a price inelastic demand so that any change in the price of such products will not
much affect its quantity demanded.
In fact, products that are regarded as essential tend to be relatively price inelastic because
households needs these goods and services and so will continue to purchase them even if their
prices rise.
2) The number of substitutes
Substitutes are goods that satisfy the same need or want. An example is tea and coffee.
If a product has many substitutes, for e.g tea, then its demand will be price elastic as consumers
can easily shift towards substitutes if the price of the product changes.
On the other hand, if a product has no or few substitutes such as water and salt, then its demand
will be price inelastic as the product become a necessity for the consumer.
In general, the greater the number and availability of close substitutes for a good or service, te
higher will be the price elasticity of demand (price elastic demand). This is because such products
are easily replaced if the price increases due to the large number of close substitutes that are
available.
On the other hand, products with few substitutes such as water will have a rice inelastic demand.
3) Proportion of income spent on a product
Generally, if a product takes up a large part of a person’s income, then the demand for the product
will be price elastic. For e.g a rise in the price of an air ticket which may lead to a big reduction in
its quantity demanded as the consumer may search for substitutes so the demand for the product
will be price elastic
On the other hand, if a product takes up a small part of a person’s income, then demand for the
product will be price inelastic. For e,g a rise in the price of bus fares will not much affect the
quantity demanded of the product.
4) Time
Over time, the demand for a product becomes price elastic (long run) as consumers may adjust
their consumption following a change in the price of a product.
However, in the short run, demand for a product will be price inelastic as consumers generally
will not change their consumption pattern.
5) Advertising and brand loyalty
Customers who are loyal to a particular brand are less sensitive to a change in its price because
the brand is demanded out of habit and personal preference so that demand for such a product
will be price inelastic.
Thus, a product will have a price elastic demand if:
a) The product is luxury good.
b) The product has many substitutes
c) The product takes up a large part of a person’s income
d) The product is not consumed out of habit
e) The consumer have enough time to adjust his consumption following a change in price
(consumed in the long run)
On the other hand, the product will have a price inelastic demand if:
a)
b)
c)
d)
e)
The product is a basic necessity
The product has few or no substitutes
The product is habit-forming
The product takes up a small part of a person’s income
The consumer has not enough time to adjust his consumption following any change in price
(consumed in the short run)
f) The consumer is loyal to a brand (or addicted to a brand)