Price elasticity of demand
Price elasticity of demand
Price elasticity of demand
What is elasticity?
The responsiveness of the quantity demanded to a change in price.
• When price rises, what happens to demand?
• It will usually fall but by how much?
• Elasticity looks at how demand falls significantly for some products and not at all for others and how this impacts strategic pricing decisions.
Price elasticity of demand
The formula
Price elasticity of demand (PED) = % change in the quantity demanded
% change in price
Ways to remember the PED formula:
•Queen over People
•QPR — Q uantity divided by Pr ice
•Think of your own but always remember price is on the bottom.
Price elasticity of demand
Worked example 1
The price per unit of water increases by 20% and as a result there is a fall in demand of 5%.
Student task
• Work out the PED.
• What does this figure mean?
Price elasticity of demand
What does the PED figure mean? (1)
Elastic demand
• If the answer is between –1 and infinity, the relationship is elastic.
• Where % change in demand is greater than % change in price.
Exam note: PED has a minus sign in front of it because as price rises demand falls and vice versa (inverse relationship between price and demand).
Price elasticity of demand
What does the PED figure mean? (2)
Inelastic demand
• If answer is between 0 and –1, the relationship is inelastic.
• Where % change in demand is less than % change in price.
Price elasticity of demand
Worked example 2
The price per chocolate bar increases by 10% and as a result there is a fall in demand of 20%.
Student task
• Work out the PED.
• What does this figure mean?
Price elasticity of demand
A figure of –2
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•
•
This means the product has elastic demand (the % change in quantity is more responsive than the change in price.) e.g.
Price increase of 1% means demand will fall by 2%.
Price increase of 10% means demand will fall by 20%.
Price increase of 20% means demand will fall by 40%.
Price elasticity of demand
Worked example 3
The price per unit of electricity increases by 10% and as a result there is a fall in demand of 5%.
Student task
• Work out the PED.
• What does this figure mean?
Price elasticity of demand
A figure of -0.5
•
•
•
This means the product has inelastic demand (the % change in quantity is less responsive than the change in price) e.g.
Price increase of 1% means demand will fall by 0.5%.
Price increase of 10% means demand will fall by 5%.
Price increase of 20% means demand will fall by 10%.
Price elasticity of demand
Price
Revenue
Total revenue is price x quantity sold.
In this example, TR = £7 x 100 = £700
This value is represented by the green shaded rectangle.
£7
Total revenue
100
D
Quantity demanded
Price elasticity of demand
How does elasticity impact revenue?
The revenue is the money coming into a business from sales (price x quantity) and there is a simple rule on the impact of elasticity:
Elastic goods
If the price increases then there will be a bigger fall in sales, which means less revenue (and vice versa).
Inelastic goods
If the price increases then there will be a smaller fall in sales, which means more revenue (and vice versa).
