Price Elasticity of Demand

You are expected to explain/analyze (AO2) the price elasticity of demand, its degrees, determinants, and relationship to revenue (SL+HL), and why it is lower for primary commodities than manufactured products (HL), evaluate/examine (AO3) the importance of price elasticity of demand for firms and government, draw (AO4) all forms of elasticity, and changes in revenue when of price changes (SL+HL), calculate (AO4) price elasticity of demand, and changes in revenue when price changes (SL+HL)

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Concept of Elasticity

Income Elasticity of Demand

Price elasticity of demand refers to how responsive the quantity demanded is for a good or service when price changes.

Calculating PED (AO4)

Ignore any negative sign!

This may be a little hard to remember, so here are the key things to keep in mind:

"New minus old over old"
Price is always on the bottom
If the value is less than 1, the product is inelastic (change in P results in less change in Q)
If the value is more than 1, the product is elastic (change in P results in more change in Q)

Degrees of PED (AO2 +AO4)

<- Use the arrows to go through the 5 degrees of PED! You are expected to know how to draw these

Determinants of PED (AO2)

Number and closeness of substitutes: If there are many similar alternatives to a good, it is easy to switch, making it more price elastic (PED > 1)
Degree of necessity: If it is very necessary to life, people will still buy it regardless of price, making it more price inelastic (PED < 1)
Proportion of income spent on good: If people only spend 0.1% of their income on a good, their demand will not really change if it doubles to 0.2%. However, if it doubles from 25% to 50%, demand is likely to drop significantly.
Time: Humans take time to change their behavior, and that includes reducing their demand. In a short timespan, demand for any good is unlikely to change by a lot.

Relationship between PED and total revenue (AO2)

If you're selling a good that is price inelastic of demand, it means increasing the price by 10% will lead to a decrease of sales less than 10%. Hence, you can increase the price to increase revenue.
If you're selling a good that is price elastic of demand, it means increasing the price by 10% will lead to a decrease of sales more than 10%. Hence, you can lower price to increase revenue.

(HL) Why is PED lower for primary commodities than manufactured products? (AO2)

Primary commodities refer to raw, mostly unprocessed materials, such as timber, metals, and crude oil
Because there are very few close substitutes (what is an easy replacement for gold, for example?) buyers have little choice but to purchase at higher prices, should prices increase
For manufactured goods, for example, there are many alternatives. For example, if Apple increases their phone prices, there are dozens of Android manufacturers that offer (relatively) easy substitutes

Why is PED important for governments and firms? (AO3)

Taxes on inelastic goods will do little to reduce demand, but will be very effective on elastic goods
Subsidies on inelastic goods will do little to increase demand, but will be very effective on elastic goods
For firms who want to increase revenue, they could try to determine their goods' PED and that way see if they should increase or decrease prices

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