Price elasticity of demand (PED) measures consumer responsiveness when the price of a product or a service changes. It shows how consumers react -- if they buy more or less -- when a certain good's price rises or falls and if a higher price can cover up for lower demand, and vice versa. Do not confuse it with income elasticity on demand, which focuses on changes in consumer income, rather than fluctuations in product price.
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Price Elasticity of Demand Formula
Price elasticity of demand is defined as the percentage of change in quantity demanded divided by the change in price percentage. According to the law of demand, this ratio tends to be negative, as the more expensive the product, the less people will ask for it in the market. For example, if a cellphone's price increases by 10 per cent and demand for it subsequently decreases by 8 per cent, then you have a PED of (-8)/5 = -1.6.
Certain types of products can be inelastic, PED = zero, when changes in price do not affect consumer habits in any way. This can happen because these products are so greatly important to consumers, no change in price can prevent them from buying them. An example of such products is medicine: a sick person whose life depends on a medicine will buy it whether it costs 60p or £16.
Another special category of products is one with positive PED. This means that when those products become more expensive, consumers want them more, but when those products are cheap, demand for them is low. An example of such products is the so-called Veblen goods: luxury products and services, primarily aimed at conspicuous consumption. Owners of such products do not purchase them to satisfy a need, but to display their wealth; therefore, the more expensive the better.
Factors Affecting Price Elasticity of Demand
The availability of substitutes in a market affects a product's PED greatly, as it is easier for a consumer to abandon an expensive product if a readily available cheaper option is available. Also, if the product is more of a necessity, such as food, than a luxury item, then it tends to have smaller elasticity. Temporary and permanent price changes also have different results, as a consumer can continue buying a product if he knows the price will go back to normal shortly. In addition, products that consume a large portion of a person's budget tend to have greater elasticity.
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