Defining the first elasticity of demand: PED
PED measures the responsiveness of demand to a change in the price level. As we already know, the demand curve is downwards sloping as at a higher price, consumers demand less of a good (due to diminishing marginal returns). However, this can vary depending on certain factors that can affect how much demand changes with the same price change. We use PED to measure this change in demand in proportion to the price change – essentially, it is the gradient of the demand curve.
The equation for PED is the percentage change in demand divided by the percentage change in price, and will always be negative for a good (with the exception of Veblen and Giffen goods) as when the price goes up, demand falls and vice versa.
A PED value between 0 and -1 means it is price inelastic, and so demand changes by a smaller percentage than the price. A PED value lower than -1 means it is price elastic, and so demand changes by a greater percentage than the price. When PED = 0, it is perfectly inelastic, and it is perfectly elastic when PED = ∞. Finally, when PED = -1, it is known as unitary elasticity.
The PED value can be interpreted as such: when the price rises by 1x%, demand falls by y% (y being the value of PED). For example, when PED = -3, when the price rises by 1%, demand falls by 3%.
As mentioned previously, PED depends on different factors that can affect how much demand changes by when the price changes. The factors influencing PED are the following:
- Necessity – is the good a necessity? If so, then demand will fall by a lower amount as people still need to buy the goods, e.g. medicine
- Availability of substitutes – are there any other similar goods or competing firms? If consumers have no alternative, then demand won’t fall by much as they can’t buy it anywhere else, e.g. energy
- Time Period – are the goods being demanded in the short- or long-run? If a good is being demanded in the short-run, demand will be more elastic as consumers can switch quickly, whereas if it is long-run then they will have to wait before they can change and so demand would be less responsive.
- % of income – does the good cost a large percentage of income? If the good takes a large proportion of a person’s income, demand will be more elastic as even the smallest change in price can cost them a hefty amount (e.g. housing), whereas good that takes up a small amount of income would not matter as much (e.g. chocolate)
- Brand Loyalty – has the company established a connection with the consumer? If consumers feel some sort of connection or loyalty to the brand, then they become less responsive to price rises, e.g. Starbucks
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