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Interpreting PED and YED

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Business Studies

Imagine you walk into a shop, searching for your favourite brand of chocolate but you see that its price has doubled and a similar type of chocolate is on sale. What would you do in this situation? Certain consumers might pick the cheaper but still similar chocolate. This is due to the elasticity of demand.

Price elasticity of demand (PED)

Price elasticity of demand (PED) measures how responsive demand is to a change in price, and hence, is a useful tool for making marketing decisions.

In other words, it measures how much demand for a product or service changes if the price of that product or service changes. We measure PED to answer the following question: if the price of a product changes, how much does demand increase, decrease, or stay the same?

Understanding PED is important for managers, as they will know how a price change will impact demand for their products. This is directly related to the amount of revenue and profit the business makes. For example, if PED is elastic and the company decides to decrease prices, demand will increase by a larger proportion than the decrease in price which will, in turn, increase revenues.

PED is also useful for marketing managers when it comes to the marketing mix. PED has a direct impact on the 'Price' element of the marketing mix. This helps managers understand how to price current and new product developments.

PED formula and example

Price elasticity of demand can also be defined as the percentage change in quantity demanded divided by the percentage change in price. To calculate the price of elasticity of demand, we use the following formula:

Interpreting PED and YED, ped formula

At the beginning of the year Product A was selling at £2 and demand for Product A was 3,000 units. The next year Product A was selling at £5 and demand for Product A was 2,500 units. Calculate the price elasticity of demand.

A PED of -0.11 implies inelastic demand.

Meaning of PED

After we have calculated PED, we need to understand how to interpret the value. There are three different expected outcomes:

| PED | > 1: If the absolute value of PED is greater than one it means that demand is elastic. Elastic demand implies that a small price change will result in a large change in demand. Elastic demand is usually common for substitutable goods. For example, if the price of Coca-Cola increases by 25 pence, demand for it will probably decrease, as consumers will choose Pepsi or other soft drinks instead. Demand also tends to be elastic for luxury goods.

| PED | <1: if the absolute value of PED is smaller than one it means that demand is inelastic. Inelastic demand implies that a small change in price will result in an even smaller change in demand. In other words, even if the price changed significantly (large increase or large decrease), demand would not change very much. Inelastic demand is common for goods that are necessities. For example, if you increased the price of basic food items by a lot, demand for them will most likely not change very much.

| PED | = 1: if the absolute value of PED is equal to one, it means that demand is unitary. Unitary elastic demand is where one unit of change in price results in the same unit change in demand. This type of elasticity is quite uncommon. This would mean that if we were selling 100 units of a product at £100 and increased the price to £101, demand would decrease to 99 units.

Income elasticity of demand (YED)

Income elasticity of demand (YED) measures how responsive demand is to a change in income, and hence, is another useful tool for making managerial decisions.

Demand is not only affected by price (PED), it is also affected by consumer income (YED). YED measures how much the demand for a product or service changes if there is a change in real income. We measure YED to answer the following question: if consumers' income changes, how much does demand for goods and services increase, decrease, or stay the same?

Most products have a positive income elasticity of demand. This is because as consumers' income increases, they demand more products and services at each price.

YED formula and example

Income elasticity of demand can also be defined as the percentage change in quantity demanded by the percentage change in real income. To calculate the income of elasticity of demand, we use the following formula:

Interpreting PED and YED, yed formula

At the beginning of the year, consumers were earning on average £18,000 and demanding 100,000 units of Product A. The next year consumers were earning on average £22,000 and demand was 150,000 units of Product A. Calculate the price elasticity of demand.

A YED of 2.25 implies elastic demand.

Meaning of YED

After we have calculated YED, we need to understand how to interpret the value. There are three different expected outcomes:

YED> 1: If YED is more than one, it implies income elastic demand. This means that a change in income will result in a proportionally larger change in quantity demanded. A YED that is bigger than 1 tends to be the case for luxury goods - as average income increases, consumers tend to spend more of their income on luxuries like branded consumer goods or luxury holidays.

YED <0: If YED is smaller than zero, it implies a negative elasticity of demand. This means that an increase in income will result in a proportionally larger decrease in quantity demanded. In other words, when income increases consumers demand less of this product. A YED smaller than zero tends to be the case for inferior goods. When consumers purchase less of certain goods when their income increases, these types of goods are known as inferior goods. An example of inferior goods would be own-branded grocery items, or budget food items.

0 <YED <1: If YED is larger than zero but smaller than 1, it implies that an increase in income will lead to an increase in quantity demanded. This tends to be the case for normal goods. Normal goods exhibit a positive relationship between income and demand. Normal goods include products like clothing, household appliances, or branded food items.

Interpreting PED and YED - Key takeaways

  • Price elasticity of demand measures how responsive demand is to a change in price.
  • PED can be measured by dividing the percentage change in quantity demanded by the percentage change in price.
  • Income elasticity of demand measures how responsive demand is to a change in income.
  • YED can be measured by dividing the percentage change in quantity demanded by the percentage change in income.
  • Luxury goods have an income elasticity of demand that is higher than 1.
  • Inferior goods are goods that consumers purchase less of when their income increases.

Interpreting PED and YED

After calculating PED, we need to interpret the result. The absolute value of PED can either be larger or smaller than one. If the absolute value of PED is greater than one it means that demand is elastic. Elastic demand implies that a small change in price will result in a large change in demand. If the absolute value of PED is smaller than one, demand is inelastic. Inelastic demand implies that a small change in price will result in an even smaller change in demand. 


PED can also be equal to one, although this is rarely the case. If the absolute value of PED is equal to one, it means that demand is unitary. Unitary elastic demand is where one unit of change in price results in the same unit change in demand.

Price elasticity of demand (PED) measures how responsive demand is to a change in price. On the other hand, income elasticity of demand (YED) measures how responsive demand is to a change in income.

PED = percentage change in quantity demanded / percentage change in price.

YED = percentage change in quantity demanded / percentage change in income.

Price elasticity of demand (PED) measures how much demand for a certain product or service changes if the price of that product or service changes. On the other hand, YED measures how much demand for a certain product or service changes when consumer income changes.

Final Interpreting PED and YED Quiz

Question

What is PED?

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Answer

Price elasticity of demand (PED) measures how responsive demand is to a change in price. In other words, it measures the extent to which demand for a product or service changes if the price of that product or service changes.

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Question

How do you calculate PED?


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Answer

PED can be calculated by dividing the percentage change in quantity demanded by the percentage change in price.

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What does it mean if the absolute value of PED is greater than one? 


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If the absolute value of PED is greater than one it means that demand is elastic.

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What does it mean if the absolute value of PED is smaller than one? 


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If the absolute value of PED is smaller than one it means that demand is inelastic.

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What does it mean if the absolute value of PED is equal to one?


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If the absolute value of PED is equal to one, it means that demand is unitary.

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Question

At the beginning of the year Product A was selling at £5 and demand for Product A was 15,000 units. The next year Product A was selling at £6 and demand for Product A was 12,000 units. Calculate the price elasticity of demand.


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Answer

Change in quantity demanded = (12,000-15,000) / (15,000) = -0.2 = - 20%


Change in price = (6-5) / (5) = 0.2 = 20% 


PED = -20% / 20% = 1 


A PED of 1 implies that demand is unitary. 

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Question

What is YED? 


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Answer

Income elasticity of demand measures how responsive demand is to a change in income.

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How do you calculate YED? 


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YED can be calculated by dividing the percentage change in quantity demanded by the percentage change in real income.

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What does a YED larger than 1 imply? 


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Answer

If YED is more than one, it implies income elastic demand. This means that a change in income will result in a proportionally larger change in quantity demand.

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What does a YED that is smaller than 0 imply? 


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Answer

If YED is smaller than zero, it implies a negative elasticity of demand. In other words, when consumers' average income increases, they demand less of the product.

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Question

What does it mean when YED is between 0 and 1?


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Answer

YED is between 0 and 1 for normal goods. It implies that an increase in income will lead to an increase in the quantity demanded.


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What is an inferior good? 


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Answer

An inferior good is a product that consumers demand less of when their income increases.

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Name an example of a normal good.

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Answer

Clothing.

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Question

In 2004 consumers were earning on average £19,000 and demanding 1 million units of Product A. In 2005 consumers were earning on average £22,000 and demanded 500,000 units of Product A. Calculate the income elasticity of demand. What could this YED signify?


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Answer

Change in quantity demanded = (500,000 - 1,000,000) / (1,000,000) = -0.5 = -50%


Change in income = (22,000 - 19,000) / (19,000) = 0.16 = 16% 


YED = -50% / 16% = -3,125


A YED of -3,125 implies negative elasticity of demand. This could signify that the good is inferior. 

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Question

Which of the following tends to be true for luxury goods?

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Answer

| PED | > 1 

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For inelastic demand, | PED | is

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<1

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An elastic demand is characterised by 

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Answer

| PED | > 1

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If the price of groceries were to go high by a few units, its demand would not change very much.

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Answer

True

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One unit of change in price results in the same unit change in demand. This is true for


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unitary elastic demand.

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Question

_____ measures how much demand for a product or service changes if the price of that product or service changes. 


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Answer

PED

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Question

If PED is elastic and the company decides to decrease prices, demand will ________ by a larger proportion than the decrease in price.


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Answer

increase

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Which of the marketing mix element(s) is affected by the PED?

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Answer

Price

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Products that have substitutes in the market have a |PED|

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Answer

> 1

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Expand YED.

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Answer

Income elasticity of demand  

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Most products have 


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positive income elasticity of demand.

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A negative elasticity of demand is shown by 

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Answer

YED < 0

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What does 0 < YED < 1 imply in terms of income and demnd?

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Answer

It implies that an increase in income will lead to an increase in the quantity demanded.  

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For normal goods, 

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Answer

0 < YED < 1 

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For luxury goods,

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YED > 1

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For inferior goods, 

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Answer

YED < 0

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