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APPLICATION OF PED

• PED and business decisions - the effect of price


changes on revenue
• PED is important for business decision making as it determines the
effect of price changes on total revenue (PxQ). When a business is
considering increasing or decreasing price, it is important to know the
resulting impact on demand and therefore sales revenue.
• Remember that if demand for a good or service is price inelastic then
an increase in price will decrease sales but increase sales revenue
• However, a price cut will increase sales but decrease sales revenue.
• If price elasticity is 1, then revenue does not change with a change in
price since the proportionate effects on price and quantity demanded
are equal.
PED and TR
The changes in revenue for different values are table below
elasticity summarised in the

Price elasticity value Price change Impact on firm's revenue Explanation

Elastic Increase Fall Elastic demand will mean that


when price increases, demand will
fall by a greater percentage than
the price increased. This means a
fall in revenue.
Elastic Decrease Increase Elastic demand will mean that
when price falls, demand will
increase by a greater percentage
than the price decreased. This
means an increase in revenue.
Inelastic Increase Increase Inelastic demand will mean that
when price increases, demand will
fall by a smaller percentage than
the price increased. This means an
increase in revenue.
Inelastic Decrease Fall Inelastic demand will mean that
when price falls, demand will
increase by a smaller percentage
than the price decreased. This
means a fall in revenue.
Small test
• Explain the different degree / ranges of PED
with the help of an diagram and with an
relevant examples?
• Define total revenue ? How profit is
calculated? Distinguish between cost and
revenue?
• When the demand is inelastic.
What happens to the total revenue and price?
Define inelastic?
PED - primary vs manufactured goods

PRIMARY COMMODITIES MANUFACTURED PRODUCTS


• GOODS DIRECTLY • PRODUCTS THAT HAVE
ARISING FROM THE USE BEEN MADE FROM RAW
OF NATURAL
RESOURCES MATERIALS
• EX: AGRICULTURAL , • EX: TV,CAR, MOBILE,
FORESTRY PRODUCT,AS LAPTOP, FURNITURE
WELL AS PRODUCTS OF
EXTRACTIVE INDUSTRY
(OIL,COAL,MINERALS)
• Generally primary commodities have relatively low PED
values (inelastic), while manufactured goods will tend
to have higher values (more elastic).
• The availability of close substitutes in the market. The
more substitutes available the greater the elasticity.
• Is the good a luxury or necessity? Luxuries are more
elastic in demand than necessities.
• Proportion of income spent on them. Cheap items
tend to have an inelastic demand.
• Are they addictive? These obviously become price
inelastic.
• The time period. Elasticity tends to increase with time.
In the table below is a comparison of two products - wheat (a primary
commodity) and laptops (a manufactured good) - against each of these
determinants.

Determinants Wheat Laptop

Availability of close substitutes Relatively few substitutes - effectively a Reasonable number of substitutes
necessity depending on precise task (e.g. tablet,
computer )

Luxury or necessity? Necessity Luxury

Proportion of income spent Depends on nature of economy, but Depends on nature of economy, but
generally relatively low generally relatively high - a one-off
purchase

Addictive N/A N/A (Unless you are a gamer?)

Time period Used over a short period - consumed Used continously over a long period
immediately

Number of uses Single use - food Multiple uses - writing, searching,


gaming...
• This helps us see why primary commodities
will generally have a lower elasticity value
than manufactured goods which will tend to
be higher value luxuries rather than
necessities and therefore more elastic.
PED IN RELATION TO PRIMARY AND
MANUFACTURED GOOD

Large price fluctuations over short periods of


time are referred to as price volatility.
THE PRICE OF PRIMAR PRODUCTS TEND TO BE
MUCH VOLATILE - DUE TO CHANGE IN
WEATHER CONDITION, NATURAL DISASTER-
FLOODS, DROUGHT
Many primary commodities have a relatively low
PED (price inelastic demand) because they are
necessities and have no substitutes (for example,
food and oil).
The PED of manufactured products is relatively high
(price elastic demand) because they usually have
substitutes.
PED , INDIRECT TAX AND GOV
REVENUE