The responsiveness of demand to changes in price is measured by price elasticity of demand (ped).
For some products a price change will result in a large change in demand and for others a smaller change.
Calculating price elasticity of demand:
Percentage change in quantity demanded
Percentage change in price
PED is always a negative number - but we ignore this.
Price inelastic demand:
When the result of the calculation is less than one.
The percentage change in demand is less than the percentage change in price.
An increase in the price of a price inelastic product will increase revenue.
A reduction in price will decrease revenue.
Setting a high price (skimming) is much more likely for a price inelastic product.
Products with price inelastic demand tend to have few substitutes.
They may also be necessities - petrol in rural areas, or addictive - cigarettes.
Price elastic demand:
When the result of the calculation is more than one.
The percentage change in demand is more than the percentage change in price.
If PED is price elastic an increase in price will reduce revenue.
However, lowering prices will increase revenue for a price elastic product.
Lowering price policies (competive pricing) are more likely when a product is price elastic.
Price elastic products would be expected in a very competitive market.
Unitary price elasticity:
When the result of the calculation is exactly one.
The percentage change in demand is exactly the same as the percentage change in price.
Influences on the price elasticity of demand:
Demand is likely to be more price inelastic if:
- The product is heavily branded so customers are not especially sensitive to price changes.
- There are few substitutes.
- A relatively low proportion of income is spent on this product so customers are less sensitive to a price change.
More details on PeD here.
Price elasticity of demand video 1.
Price elasticity of demand video 2.
