Price Elasticity of Demand (PED)

PED: The price elasticity of demand measures the responsiveness of consumer demand to changes in price of goods and services.

Price elastic demand: When a small change in price causes a large change in the quantity demanded. The slope of the demand curve will be gentle

Price inelastic demand: When a small change in price causes a small change in the quantity demanded. The slope of the demand curve will be steep

Examples of price elastic demand:

• Luxury cars, Bentleys for example

• Apple laptops

Examples of price inelastic demand:

• Medicines

• Basic food grains

How to calculate price elasticity of demand:

% change in demand / % change in price

If PED value<1 and >0 then it is said to be price inelastic demand

If PED value>1 then it is said to be price elastic demand

Determinants of Price Elasticity of Demand:

1. The availability of substitutes

If close substitutes for a commodity are available, its demand tends to be elastic. If the price of this type of commodity goes up, the consumers will shift to buying its close substitutes and as a result the demand for that commodity will decline by a huge margin. The greater the possi­bility of substitution, the greater the price elasticity of demand for it. If substitutes are not available, people will have to buy it even when its price rises, and therefore its demand would tend to be inelastic.

2. Portion of consumer incomes spent

The proportion of consumer’s income spent on a particular commodity also influences the elasticity of demand for it. The greater the proportion of income spent on a commodity, the greater will be generally its elasticity of demand, and vice versa. The demand for common salt, soap and such other goods tends to be highly inelastic because the households spend only a fraction of their income on each of them. When the price of such a commodity rises, it won't make much of a difference in consumers’ budget and hence, they will continue to buy almost the same quantity of that commodity and, therefore, the demand for them will be inelastic.

3. Time to look for substitutes

The element of time also influences the elasticity of demand for a commodity. Demand tends to be more elastic if the time involved is long. This is because consumers can substitute goods in the long run. In the short run, substitution of one commodity by another is not so easy. The longer the period of time, the greater is the ease with which both consumers and businessmen can substitute one commodity for another.

4. If the product is a necessity

If the product is a necessity which is very essential for our survival, the demand for it will be more inelastic. For example, salt is a basic necessity and so, changes in the price of it do not reduce quantity demanded greatly. It is unlikely for the demand for a good that is a necessity to contract due to a change in prices.

5. Cost of switching to a different supplier

Switching demand to an alternative supplier can be expensive even if their products are cheaper as it may mean breaking a contract with your existing supplier.

Importance of knowledge of PED to firms

It is not sensible to raise the price of a price elastic product because it has many close substitutes. Consumers will switch to cheaper alternatives and revenue will decrease. Firms can persuade the consumers through advertising like promotions and gifts that their product is better quality than rival firms, offer discounts and free gifts. Firms can also conversely raise the price of an inelastic product because it doesn't have many close substitutes.

Importance of knowledge of PED to governments

Using tax to increase the price of a product whose demand is elastic would help discourage the consumption such as plastic bags. However, using to increase the price of a product whose demand is price inelastic would not have much effect. For example, levying a tax on cigarettes would not have much effect since it is an addiction to many.