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A description of the price elasticity of demand

Study the patterns of numbers and see if you can analyse the relationships between the three measures of revenue — then answer the following: How are price and average revenue connected? What happens to total revenue as output increases? What is the connection between total revenue and marginal revenue?

Price elasticity of demand

How are marginal revenue and average revenue connected? TR increases, reaches a peak and decreases. Why does a firm want to know PED? There are several reasons why firms gather information about the PED of its products. A firm will know much more about its internal operations and product costs than it will about its external environment.

Therefore, gathering data on how consumers respond to changes in price can help reduce risk and uncertainly. More specifically, knowledge of PED can help the firm forecast its sales and set its price. Sales forecasting The firm can forecast the impact of a change in price on its sales volume, and sales revenue total revenue, TR.

Pricing policy Knowing PED helps the firm decide whether to raise or lower price, or whether to price discriminate. Price discrimination is a policy of charging consumers different prices for the same product. If demand is elastic, revenue is gained by reducing price, but if demand is inelastic, revenue is gained by raising price.

Price elasticity of demand

Non-pricing policy When PED is highly elastic, the firm can use advertising and other promotional techniques to reduce elasticity. Determinants of PED There are several reasons why consumers may respond elastically or inelastically to a price change, including: The degree of necessity of the good A necessity like bread will be demanded inelastically with respect to price.

Whether the good is habit forming Consumers are also relatively insensitive to changes in the price of habitually demanded products. The proportion of consumer income which is spent on the good The PED for a daily newspaper is likely to be much lower than that for a new car! Whether consumers are loyal to the brand Brand loyalty reduces sensitivity to price changes and reduces PED.

Life cycle of product PED will vary according to where the product is in its life cycle. When new products are launched, there are often very few competitors and PED is relatively inelastic.

As other firms launch similar products, the wider choice increases PED.

  • Whether the good is habit forming Consumers are also relatively insensitive to changes in the price of habitually demanded products;
  • What happens to total revenue as output increases?
  • For example, if the price of Cola A doubles, the quantity demanded for Cola A will fall when consumers switch to less-expensive Cola B;
  • Advertisers use a range of media, including television, press, and electronic media.

Finally, as a product begins to decline in its lifecycle, consumers can become very responsive to price, hence discounting is extremely common. Test your knowledge with a quiz Press Next to launch the quiz You are allowed two attempts - feedback is provided after each question is attempted. The effects of advertising Firms may use persuasive advertising by to win new customers and retain the loyalty of existing ones. Advertisers use a range of media, including television, press, and electronic media.

  1. As the price of gasoline increases, the quantity demanded doesn't decrease all that much. Unit elasticity, where all the possible price and quantity combinations are of the same value.
  2. How it works Example. If demand is elastic, revenue is gained by reducing price, but if demand is inelastic, revenue is gained by raising price.
  3. Determinants of PED There are several reasons why consumers may respond elastically or inelastically to a price change, including. The proportion of consumer income which is spent on the good The PED for a daily newspaper is likely to be much lower than that for a new car!

Advertising will shift demand to the right, and make demand less elastic. There are three extreme cases of PED. Perfectly elastic, where only one price can be charged. Perfectly inelastic, where only one quantity will be purchased.

Price Elasticity of Demand (PED)

Unit elasticity, where all the possible price and quantity combinations are of the same value. The resultant curve is called a rectangular hyperbola. PED can also be illustrated through indifference curve analysis Other stories.

  1. As other firms launch similar products, the wider choice increases PED.
  2. Therefore, gathering data on how consumers respond to changes in price can help reduce risk and uncertainly. As the price of gasoline increases, the quantity demanded doesn't decrease all that much.
  3. More specifically, knowledge of PED can help the firm forecast its sales and set its price.
  4. PED can also be illustrated through indifference curve analysis Other stories.
  5. As gas price goes up, the quantity of gas demanded will go down.