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PED and YED

PED and YED

Imagine you walk into a shop, searching for your favourite brand of chocolate, but you see its price has doubled. However, you notice that 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 price elasticity of demand (PED). Now, imagine that you got a new job that pays you twice the salary you were earning before. Would you still opt for the same chocolate, or would you consider buying a more expensive one? Certain consumers might opt to try out more expensive brands due to the income elasticity of demand (YED). To learn more about the impacts of PED and YED, read along!

PED Definition

PED stands for price elasticity of demand and can be defined as follows.

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

In other words, it measures how much demand for a good 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 it helps them understand how a price change will impact demand for their products. This is directly related to the revenue and profit the business makes. For example, if PED is elastic, and the company decides to decrease prices, demand will increase significantly more than the price decrease, potentially increasing company revenues.

PED is also useful for marketing managers regarding the marketing mix. PED directly impacts the 'price' element of the marketing mix. As a result, PED helps managers understand how to price current and new product developments.

YED Definition

YED stands for income elasticity of demand and can be defined as follows.

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

Demand is not only affected by price (PED) but also 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 or decrease? Or does it stay the same?

Many products have a positive income elasticity of demand. As consumers' income increases, they demand more goods and services.

However, it is essential to note that this is not always the case. The demand for certain goods decreases when consumers make more money. We discuss these types of goods in more detail in the following sections.

Calculating PED and YED

Now that we understand the meaning of price and income elasticity of demand let's examine how to calculate PED and YED.

PED and YED: Calculating PED

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:

At the beginning of the year Product A was selling at £2, and demand for Product A was 3,000 units. The following 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.

Read along to find out more on how to interpret PED.

PED and YED: Calculating YED

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:

At the beginning of the year, consumers earned on average £18,000 and demanded 100,000 units of Product A. The following 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 income elastic demand.

Read along to find out more on how to interpret YED.

Difference between PED and YED

Besides the differences in definition and calculation, the interpretation of PED and YED also vary.

PED and YED: Interpreting PED

After calculating PED, we need to understand how to interpret its value. There are three different expected outcomes:

|PED| > 1: Demand is elastic if the absolute value of PED is greater than one. Elastic demand implies that a small price change will result in a significant shift in demand. Elastic demand is usually observed 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 drink alternatives instead.

Demand also tends to be elastic for luxury goods.

For instance, if the price of aeroplane tickets and hotels increases by 30%, consumers will likely be more reluctant to book holidays.

|PED| <1: if the absolute value of PED is smaller than one, demand is inelastic. Inelastic demand implies that a small price change will result in an even smaller change in demand. In other words, even if the price changed significantly (significant increase or decrease), demand would not change much. Inelastic demand is common for goods that are necessities.

For example, if the price of essential food items like bread, milk, and rice increases by 15%, demand for them will likely not change much as consumers will always need basic food items.

|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 relatively uncommon. Unitary elastic demand would imply that if a company sold 100 units of a product at £100 and increased its price to £101, demand would decrease to 99 units.

Figure 1 below summarises the relationship between the value of PED and the elasticity of demand.

PED and YED: Interpreting YED

Similarly to PED, we need to understand how to interpret the value of YED. There are three different expected outcomes:

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.

YED> 1: If YED is much higher 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 larger than 1 tends to be the case for luxury goods - as average income increases, consumers tend to spend more on luxuries like designer clothes, expensive jewellery, 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 the quantity demanded. In other words, consumers demand less of this product when income increases. A YED smaller than zero tends to be the case for inferior goods.

Inferior goods are goods and services consumers demand less of when their income increases.

An example of inferior goods would be own-branded grocery items or budget food items.

To learn more about store brands, check out our explanation of Branding Strategy.

Figure 2 below summarises the relationship between the value of YED and the type of goods associated with it.

Importance of PED and YED

So, why is it important to understand PED and YED? Marketers always seek to understand consumer behaviour. They look for changes in consumer attitudes, perceptions, and buying behaviour. Therefore, the way consumers perceive and respond to prices will be of interest to marketers.

For instance, if a business is selling luxury products, it knows that the demand for its products is elastic. As a result, a company selling luxury holiday packages might decide to introduce price promotions during a time when the average consumer income is lower than in previous years.

Check out our explanation of Promotional pricing to explore this pricing strategy in more detail.

On the other hand, consider a supermarket that makes most of its revenue from selling lower-cost private label (store brand) products. Suppose the economy is experiencing healthy growth and consumers earn more money on average. In that case, the supermarket might consider introducing a new product line or brand that includes a selection of higher-end consumer goods.

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.

Frequently Asked Questions about PED and YED

PED is the Price elasticity of demand and YED is the Income elasticity of demand. PED measures how responsive demand is to a change in price, and YED measures how responsive demand is to a change in income.

PED and YED measure how customer demand is affected by a change in price and a change in income. Although changes in product prices impact how much customers demand a product, changes in customer incomes do too. 

PED can be interpreted as:

If | PED | = 1, the demand is unitary,

If | PED | > 1, the demand is elastic,

If | PED | < 1, the demand is inelastic.

On the other hand, YED can be interpreted as follow:

If 0<YED<1, it implies normal goods,

If YED>1, it implies luxury goods, 

If YED<0, it implies inferior goods.


To calculate PED, we use the following formula:

PED = percentage change in quantity demanded/percentage change in price. On the other hand, the formula for calculating YED is as follows:

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

Price elasticity of demand (PED) measures how responsive demand is to a change in price, while income elasticity of demand (YED) measures how responsive demand is to a change in income. They are both useful tools for making marketing decisions.

Final 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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Question

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


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Answer

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

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Question

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


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Answer

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

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Question

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


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Answer

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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Answer

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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Question

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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Question

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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Question

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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Answer

<1

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An elastic demand is characterised by 

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Answer

| PED | > 1

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Question

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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Question

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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> 1

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Question

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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Answer

YED > 1

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For inferior goods, 

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Answer

YED < 0

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