The Significance of PED (Edexcel IGCSE Economics)

Determinants of PED

Spec point — 1.1.4f

• Some products are more responsive to changes in prices than other products

• The factors that determine the responsiveness are called the determinants of PED and include:

  • **Availability of substitutes: **good availability of substitutes results in a higher value of PED (relatively elastic)
  • Addictiveness of the product: addictiveness turns products into necessities, resulting in a low value of PED (relatively inelastic)
  • Price of product as a proportion of income: the lower the proportion of income the price represents, the** lower the PED value will be**. Consumers are less responsive to price changes on cheap products (relatively inelastic)
  • Time period: In the short term, consumers are less responsive to price increases, resulting in a low value of PED(relatively inelastic). Over a longer period of time, consumers may feel the price increase more and will then look for substitutes, resulting in a higher value of PED (relatively elastic)

PED & Total Revenue

Spec point — 1.1.4g

• Revenue is the amount of money a firm receives from selling its goods/services

  • Total revenue = price x quantity

• The total revenue rule states that in order to maximise revenue, firms should increase the price of products that are inelastic in demand and decrease prices on products that are elastic in demand

• This can be illustrated using a demand curve

Diagram: Price Elastic Demand and Total Revenue

A small decrease in price from P₁ → P₂causes a large increase in quantity demanded from Q₁ → Q₂

Diagram analysis

• The demand curve is very elastic in this market
• When a good/service is price elastic in demand, there is a greater than proportional increase in the quantity demanded to a decrease in price
• Total revenue is higher once the price has been decreased
• $(P_{2}\times Q_{2})>(P_{1}\times Q_{1})$

Diagram: Price Inelastic Demand and Total Revenue

A large increase in price from P₁ → P₂causes a small decrease in quantity demanded from Q₁ → Q₂

Diagram analysis

• The demand curve is very inelastic in this market

• When a good/service is price inelastic in demand, there is a smaller than proportional decrease in the quantity demanded to an increase in price

• Total revenue is higher once the price has been increased

  • $(P_{2}\times Q_{2})>(P_{1}\times Q_{1})$

The Implications of PED for Stakeholders

Spec point — 1.1.4s

• Knowledge of PED is important to firms seeking to maximise their revenue

  • If their product is price inelastic in demand, they should raise their prices
  • If price elastic in demand, then they should lower their prices
  • Firms can choose to use price discrimination to maximise their revenue i.e. lower prices for certain segments & higher prices for others

• Knowledge of PED is important to Governments with regard to taxation and subsidies

  • If they tax price inelastic in demand products, they can raise tax revenue without harming firms too much
  • Consumers are less responsive to price changes so firms will pass on the tax to the consumer
  • If Governments subsidise price elastic in demand products, there can be a greater than proportional increase in demand

Exam Hint A common error students make is to say that when prices increase and the **product is inelastic in demand, the quantity demanded does not fall. It does! But it is a less than proportional fall **than the increase in price.

So, when Governments tax demerit goods such as cigarettes, the increase in price is greater than the decrease in QD, but QD still falls.

When asked to** evaluate** the usefulness of PED in helping the government decide whether to increase taxes, make sure to consider multiple viewpoints.