Priceelasticityofdemand.docVIP

Price elasticity of demand Price elasticity of demand PED, Ed is an elasticity used in economics to show the responsiveness of the quantity demanded of a good or service to a change in its price. More precisely, it gives the percentage change in demand one might expect after a one percent change in price. It was devised by Alfred Marshall. Price elasticities are almost always negative, although analysts tend to ignore the sign even though this can lead to ambiguity. Only goods which do not conform to the law of demand, such as Veblen and Giffen goods, have a positive PED. Goods with a small PED less than one are said to be inelastic: changes in price do not significantly affect demand e.g. drinking water. Goods with large PEDs greater than one are said to be elastic: even a slight change in price may cause a dramatic change in demand. Revenue is maximised when price is set so as to create a PED of exactly one. PEDs can also be used to predict the incidence of tax. Various research methods are used to calculate price elasticity, including test markets, analysis of historical sales data and conjoint analysis. Price Elasticity of Demand The law of demand, namely that the higher the price of a good, the less consumers will purchase, has been termed the most famous law in economics, and the one that economists are most sure of.87 To predict consumer behavior, economists use well-defined techniques evaluating the sensitivity of consumers to changes in price. Such techniques, pioneered by the great British economist Alfred Marshall 1842-1924 in the early part of this century, are the foundations of microeconomics.88 The most commonly used measure of consumers sensitivity to price is known as price elasticity of demand. It is simply the proportionate change in demand given a change in price.89 If a one-percent drop in the price of a product produces a one-percent increase in demand for the product, the price elasticity of demand is said to be one.90 Hundreds of stud