Imagine the price of all the items below has doubled? What will happen to demand?

Imagine the price of all the items below has doubled? What will happen to demand?

PED measures the responsiveness of quantity demanded to a change in price

-it is the mathematical relationship between ∆P and ∆Qd

PED = %ΔQd%ΔP

PED is always negative (because P&Q move in opposite directions) so we often drop the ‘–’ sign.

If a change in price significantly alters the quantity demanded, then PED is said to be “relatively elastic.”

If a change in price does not have much affect on quantity demanded, then PED is said to be “relatively inelastic.”

Price Elasticity of Demand

P

Q

D

P0

P1

Q0Q1

Relatively Inelastic Demand

-a large price change results in only a small change in Qd

- 0<PED <1

Price Inelastic Demand

P

Q

D

P0

P1

Q0Q1

Relatively Elastic Demand

- a small price change results in a large change in Qd

- 1 < PED

Price Elastic Demand

What determines PED? • Substitutes – the demand for a good is more

elastic when there are more close substitutes – we can easily change demand

• Necessity v. Luxury – necessity goods tend to be more inelastic as we must buy them and in fixed quantities – luxury purchases are more flexible & responsive to price

• % of income spent on the good – goods which take up a higher proportion of our income tend to be more elastic as we ‘feel’ the price change & respond to it more

What determines PED? • Time period allowed after a price change –

demand tends to be more inelastic in the short run as we cannot make changes quickly, but in the long run we can assess and change accordingly so be more elastic

• Habitual consumption – goods which are bought out of habit tend to be more inelastic as it is more difficult for the consumer to change

• Advertising / fashion / fads – goods which are ‘must have’s’ tend to be more inelastic as we are willing to pay any price (advertisers aim to make our demand more inelastic)

Perfectly Price Inelastic Demand

P

Q

D

P0

P1

Q0

Q1

Perfectly Inelastic Demand

-any price change does not change quantity demanded

- PED = 0

Perfectly Price Elastic Demand

P

Q

DP0

P1

QQ

Perfectly Elastic Demand

- infinite demand at one market price

- any price change results in no demand at all

- PED = ∞P2

P

Q

D

At small Qd, PED will be higher

At large Qd, PED will be lower

Somewhere in the middle, PED = 1

PED changes along demand

Unitary Elasticity (PED = 1)

Inelastic

Elastic

Inelastic or elastic?

• Toothpaste

• Champagne

• Cut flowers

• Bandages

• One brand of ground pepper

• A UK travel agent specialises in holidays to Spain, Greece and China. It estimates that it faces the following price elasticities of demand for these holidays:

Spain: -2.0

Greece: -1.1

China: -0.6• Discuss the possible reasons why the PED may

vary between the countries.

A little case study…

PED and Revenue

• Total revenue = P x Q

• A firm’s revenue will change with changes in either P or Q

• Depending on elasticity, changes in price will either increase or decrease total revenue

PED and RevenueP

Q

D

P0

P1

Q0Q1

Lost revenue from Qd < gain in revenue from P

- P → Revenue

Inelastic Demand

P

Q

D

P0

P1

Q0Q1

PED and Revenue

Lost revenue from Qd > gain in revenue from P

- P → Revenue

Elastic Demand

PED and Revenue

So:

Firms facing inelastic demand curves can increase revenue by increasing price

Firms facing elastic demand curves can increase revenue by decreasing price