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Price Elasticity of Demand - Coggle Diagram
Price Elasticity of Demand
PED measures the reaction of consumers to a change in the price of a good.
PED is calculated by comparing the percentage change in price with the percentage change in demand
PED = (the % change in the quantity demanded of good X)/(the % change in the price of good X)
Interpreting PED
High PED (>1) means consumers respond strongly to price changes --
Low PED (<1) means consumers respond weakly to price changes l
PED Effects on the Demand Curve
When quantity demanded of a good does not change when its price changes, demand is PERFECTLY price inelastic -- (Inelastic -> PED < 1) Demand varies without a price change
When the quantity demanded of a good falls to zero when its price changes, demand is PERFECTLY price elastic l (Elastic -> PED >1) Demand does not alter at all when price changes
The value of PED is usually negative because price and quantity demanded usually move in opposite directions.
The benchmark for elasticity is 1 therefore we ignore the minus sign and simply read the figure
Anything of more than 1 indicates elastic demand --
Anything less than 1 indicates inelastic demand l
Theoretically PED could be equal to one. This is termed unit elasticity.
It is often said that the revenue should not be affected, but when this assertion is checked with some figures, the revenue can be seen to have moved slightly.
Factors affecting PED
The closeness and amount of available substitutes.
Lots of substitutes -- Elastic
Few substitutes l Inelastic
The degree of necessity or habit of consuming the good
Necessary good (inferior product) l Inelastic
Luxury good (normal good) -- Elastic
The relationship between the price of the good and average income
Takes up high % of income -- Elastic
Takes up low % of income l Inelastic
Frequency of purchase
High frequency of purchase -- Elastic
Low frequency of purchase l Inelastic
If a product is a relatively small but vital part of something else
l Inelastic
Transaction costs
Low transaction costs -- Elastic
High transaction costs l Inelastic
Degree of dependency
Highly addictive l Very Inelastic
Not addictive -- Elastic
Time
Long term -- Elastic
Short term l Inelastic
Measures to make products more price inelastic
Producers prefer their products to be more price inelastic l as demand will not be influenced by price as much as other products
This means they can increase total revenue by increasing the price of their product.
Increase product differentiation through developing a brand name, making distinctive packaging, or increasing the quality of their product
Increase brand loyalty by offering after sales service, guarantees, discounts for repeat purchases, free gifts, competitions etc.
Increase advertising to make consumers believe that their product is significantly different to any close substitutes
Obtain patents or copyrights to ensure there are no close substitutions and therefore customers have to buy their product
Have easier credit and hire purchase terms, such as lower deposits, longer repayment periods and lower interest rates. This will make it easier for consumers to afford to buy products they might not otherwise be able to afford.
Take over rival producers to gain a bigger share of the market and increased monopoly power
Importance of PED
Importance for firms
Businesses want to know what will happen to total revenue if they change the price of their good
To increase total revenue, firms should:
Increase the price of price inelastic l products
Decrease the price of price elastic -- products
If demand is price inelastic l , price and TR move in the same direction >>
If demand is price elastic -- , price and TR move in opposite directions <>
The degree of PED determines the amount by which the price of a good will change if there is a change in its supply.
Importance for governments
Governments are interested in PED when they are considering changes to taxes
If they increase a tax on expenditure (in the UK this is Value Added Tax):
The tax revenue received from price inelastic l products will increase as there will be a proportionately smaller fall in the quantity demanded <>
The tax revenue from price elastic -- products will increase as there will be a proportionately smaller fall in the quantity demanded ><
Revenue
Total revenue
Total revenue is the total income a company generates from its business operations
It is calculated by Price per Unit * Quantity of Units Sold