Price Elasticity of Demand (PED): Types, Factors & Revenue Impact

Price Elasticity of Demand (PED)

PED measures the responsiveness of demand after a change in the good's own price.

Formula for Price Elasticity of Demand

Formula: % change in quantity demanded / % change in price

Interpreting PED Values

• PED = 0: Demand is perfectly inelastic.
• 0 < PED < 1: The percentage change in demand is smaller than the percentage change in price (price inelastic).
• PED = 1: The percentage change in demand is the same as the percentage change in price (unit elastic).
• PED > 1: Demand responds more than proportionately to a change in price (price elastic).

What factors determine the PED of a product?

Number of close substitutes

The more substitutes available to customers, the more price elastic the demand tends to be.

Price relative to consumer income

When the product represents a high proportion of a consumer's budget, demand is usually more price sensitive.

Cost of substituting between different products

When substitution or switching costs are high, demand will tend to be more price inelastic because consumers face barriers to switching.

Brand loyalty and habitual consumption

High levels of brand loyalty and habitual consumption make demand more price inelastic.

Persuasive advertising

Effective persuasive advertising can reduce price sensitivity and make demand more price inelastic.

Degree of necessity or luxury

The standard assumption is that necessities have a lower price elasticity of demand, whereas luxuries have higher elasticity since they are optional spends.

Inelastic Demand (PED < 1)

If the coefficient of price elasticity of demand is less than 1, demand is said to be price inelastic. Following a change in price, the total revenue earned by the producing firm will depend on the PED for its products. If the coefficient of PED is < 1, a rise in market price will lead to an increase in total revenue for the seller of the product.

Elastic Demand (PED > 1)

If the coefficient of price elasticity of demand is greater than 1, demand is said to be price elastic. If demand for a product is price elastic, a supplier stands to gain extra revenue if they reduce their prices because the change in quantity demanded will be proportionately higher than the reduction in price.

Perfectly Inelastic Demand (PED = 0)

If the coefficient of price elasticity of demand equals zero, demand is perfectly inelastic. A perfectly inelastic demand curve is an extreme case. It implies that consumers are willing to pay any price for the product. If supply falls, the equilibrium market price can rise without any contraction in quantity demanded.

Perfectly Elastic Demand (PED = infinity)

If the coefficient of PED is infinite, demand is perfectly elastic — there is a single price at which consumers are prepared to buy. If demand is perfectly elastic, a change in market supply will not lead to any change in the equilibrium price; instead, quantity adjusts. This demand curve typically applies to highly competitive markets where no supplier has pricing power.