Price elasticity of demand

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Price elasticity of demand
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What is elasticity?

• The responsiveness of the quantity demanded to a
  change in price.
• When price rises, what happens to demand?
• It will usually fall but by how much?
• Elasticity looks at how demand falls
  significantly for some products and not at all
  for others and how this impacts strategic pricing
  decisions.

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The formula

• Price elasticity of demand (PED) change in
  the quantity demanded
  change in price
• Ways to remember the PED formula
• Queen over People
• QPR Quantity divided by Price
• Think of your own but always remember price is on
  the bottom.

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Worked example 1

• The price per unit of water increases by 20 and
  as a result there is a fall in
• demand of 5.
• Student task
• Work out the PED.
• What does this figure mean?

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What does the PED figure mean? (1)

• Elastic demand
• If the answer is between 1 and infinity, the
  relationship is elastic.
• Where change in demand is greater than change
  in price.
• Exam note PED has a minus sign in front of it
  because as price rises demand falls and vice
  versa (inverse relationship between price and
  demand).

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What does the PED figure mean? (2)

• Inelastic demand
• If answer is between 0 and 1, the relationship
  is inelastic.
• Where change in demand is less than change in
  price.

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Worked example 2

• The price per chocolate bar increases by 10 and
  as a result there is a fall in
• demand of 20.
• Student task
• Work out the PED.
• What does this figure mean?

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A figure of 2

• This means the product has elastic demand (the
  change in quantity is more responsive than the
  change in price.) e.g.
• Price increase of 1 means demand will fall by
  2.
• Price increase of 10 means demand will fall by
  20.
• Price increase of 20 means demand will fall by
  40.

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Worked example 3

• The price per unit of electricity increases by
  10 and as a result there is a fall
• in demand of 5.
• Student task
• Work out the PED.
• What does this figure mean?

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A figure of -0.5

• This means the product has inelastic demand (the
  change in quantity is less responsive than the
  change in price) e.g.
• Price increase of 1 means demand will fall by
  0.5.
• Price increase of 10 means demand will fall by
  5.
• Price increase of 20 means demand will fall by
  10.

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Revenue
Total revenue is price x quantity sold. In this
example, TR 7 x 100 700 This value is
represented by the green shaded rectangle.
Total revenue
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How does elasticity impact revenue?

• The revenue is the money coming into a business
  from sales (price x quantity) and there is a
  simple rule on the impact of elasticity
• Elastic goods
• If the price increases then there will be a
  bigger fall in sales, which means less revenue
  (and vice versa).
• Inelastic goods
• If the price increases then there will be a
  smaller fall in sales, which means more revenue
  (and vice versa).