Differences in PED

Differences in PED
PED for the same products can differ with time. What were once seen as luxuries can turn
into necessities as people become richer. This changes their demand from elastic to inelastic.
In Europe and the USA, almost every teenager now has a mobile (cell) phone and a rise in
price would not discourage many from buying the latest model. A wide range of other
products, including TVs and cars, are seen as being essential requirements to sustain a
modern lifestyle.
Due to different tastes, different income levels and different cultures, PED can also be found
to vary between countries. Demand for rice is more inelastic in Bangladesh than it is in the
USA, where it competes with a greater range of food products. In India, where cricket has a
devoted following, demand for tickets to international cricket matches is more inelastic than
it is in the Netherlands, where it is a relatively new sport.
PED and the total spending on a product and revenue gained

When demand is inelastic, a change in price will cause total revenue (and total spending) to
move in the same direction. So a rise in price will cause total revenue to rise. When demand
is perfectly inelastic, a change in price will not only cause revenue to move in the same
direction, but also by the same percentage. For instance, the price may originally have been
$10 and 50 units may have been sold. Total revenue would have been $500. If the price rose
by 20% to $12, the quantity demanded would stay the same at 50 and so revenue would also
rise by 20% to $600.
When demand is elastic, a change in price results in total revenue moving in the opposite
direction. In this case, a rise in the price will cause total revenue to fall. In the case of
perfectly elastic demand, a rise in price will cause demand to fall to zero.
In the case of unit elasticity of demand, price and the quantity demanded change by the
same percentage and so total revenue remains unchanged. It is interesting to note that it
is the quantity demanded which remains unchanged when price changes in the case of
perfectly inelastic demand, whereas it is total revenue which does not change in the case of
unit price elasticity of demand.
Changes in PED
PED becomes more elastic as the price of a product rises. Consumers become more sensitive
to price changes, the higher the price of the product. This is because, for example, a 10%
rise in price when price was initially $10 000 would involve consumers having to spend
considerably more ($1000) to buy the product. If a supplier was foolish enough to keep
raising the price, a point would come when the product would be priced out of the market.
At this point, demand would be perfectly elastic.
As the price falls, demand becomes more inelastic. For example, a 10% fall in price when the
price was initially $1 is not very significant and is unlikely to result in much extra demand.
If the price falls to zero, there will be a limit to the amount people want to consume. At this
point, demand is perfectly inelastic. The diagram below shows how PED varies over a straight
line demand curve. At the mid-point there is unit PED, with the percentage change in
quantity demanded matching the percentage change in price.
P
PED > 1
PED = 1
PED < 1
d
Q
Variation of PED over a demand curve
PED also changes when there is a shift in the demand curve. The more consumers want and
are able to buy a product, the less sensitive they are to price changes. So a shift in the
demand curve to the right reduces PED at any given price.
Exercise:
From the diagram below, calculate the initial PED when price falls from $10 - $9. Then
calculate the PED following the demand shifts to d1.
P ($)
10
9
d1
d
20 30 40 50 Q
The effect of an increase in demand on PED
Obviously, when demand decreases, consumers become more sensitive to price changes and
demand becomes more elastic.
Implications of PED for decision making
A change in a product’s price is often the main influence on its demand. This is one of the
reasons why economists study the effect of a price change in some depth.
Consumers are more likely to benefit from lower prices and higher quality when demand
is elastic. This is because producers would be reluctant to raise price as demand would
contract by a greater percentage and revenue would fall. The quality may also be high if the
elastic demand is the result of the existence of close substitutes. In this case, a producer may
have to provide a good quality product to remain competitive.
It is widely recognised that a fall in price will result in an extension in demand. A producer,
however, in considering whether to cut the price of a product will need to know the extent
of any rise in demand. If demand is going to rise by only a relatively small amount, it may not
pay to reduce the price. For instance, the producer’s firm may be currently selling 100 units a
day at $4 each and hence earning a total revenue of $400. If it is expected that by lowering
its price to $3, demand will only rise to 120, the firm would experience a fall in revenue of
$40.
A producer may try to make the firm’s product more distinctive. This would discourage
consumers switching to other firms’ products as they would not be seen as such close
substitutes. It would make demand for the firm’s product more price inelastic and would give
the producer more power to raise price.
While taking a decision on its subsidy and taxation policies, a government also needs to
know the responsiveness of the quantity demanded to a change in price. It may, for instance,
be seeking to discourage consumption of a certain product. In this case, it is more likely to be
successful if demand is elastic. If, however, demand for a product does not alter much with a
change in price, placing a tax on such a product will not be a very effective way of achieving
this aim.

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Differences in PED

PED and the total spending on a product and revenue gained

The effect of an increase in demand on PED

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