Price Elasticity of Demand
We studied the measurement of how much a change in price will then lead to a change in the quantity demanded, called price elasticity of demand.
We calculate the percentage changes in Qd and in P, and then use them in a formula to calculate a PED value. All PED values are negative, due to the negative (or inverse) relationship between price and demand, called the law of demand.
If a change in price leads to no change in demand, the PED value is 0, and this is called perfectly inelastic demand. If a change in price leads to a lesser change in demand, the PED value is between 0 and -1, and this is called inelastic demand. If a change in price leads to the same amount of change in demand, the PED value is 1, and this is called unit elastic demand. If a change in price leads to a larger change in demand, the PED value is more than -1, and this is called elastic demand. Differently sloped demand curves can also be drawn to show different PED values.
The PED of a particular product is affected by a number of factors. Firstly, the width of definition of the product needs to be decided (for example, are we discussing milk sold at Bellerbys Brighton, milk sold in the UK, all of the milk sold in the world….?). This is important to decide because it also helps us to decide the number of substitutes for the product. Next, we decide if the product is a necessity or a luxury, how addictive it is, and what percentage of income it takes to buy it. Putting all that information together, we can then say if we think the product will have elastic or inelastic demand, and predict a possible PED value for it.
Knowing the PED value of a product is especially important for firms, who can know whether it is better for them to have a higher or lower price. Firms with inelastic demand will gain more revenue from a higher price, while those with elastic demand get more revenue from a lower price.
In summary, this was yet another exciting class on Mr Spottiswoode’s economic course.
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