Price Elasticity of demandPrice elasticity of demandmeasures theresponsiveness of demandafter a change in priceThe formula for calculating the co-efficient of elasticity of demand is:Percentage change in quantity demanded divided by the percentage change in priceValues for price elasticity of demand1. If Ped = 0demand isperfectly inelastic- demand does not change at all when the price changes the demand curve will be vertical.2. If Ped is between 0 and 1(i.e. the % change in demand from A to B is smaller than the percentage change in price), thendemand is inelastic.3. If Ped = 1(i.e. the % change in demand is exactly the same as the % change in price), then demand is unit elastic. A 15% rise in price would lead to a 15% contraction in demand leaving total spending the same at each price level.4. If Ped > 1, then demand responds more than proportionately to a change in price i.e.demand is elastic. For example if a 10% increase in the price of a good leads to a 30% drop in demand. The price elasticity of demand for this price change is 3Example: Demand for rail servicesAt peak times, the demand for rail transport becomes inelastic and higher prices are charged by rail companies who can then achieve higher revenues and profitsExample: Shell PetrolWe say that petrol is overall inelastic. But, if an individual petrol station increases price, people will buy from other petrol stations. The only exception is if a petrol station has a local monopoly e.g. at service station on the motorway there is a captive audience. But, in a city centre with many alternatives, people will have an elastic demand.

Factors affecting price elasticity of demand The number of close substitutes the more close substitutes there are in the market, the more elastic is demand because consumers find it easy to switch The cost of switching between products there may becostsinvolved in switching. In this case, demand tends to be inelastic. For example, mobile phone service providers may insist on a 12 month contract. The degree of necessity or whether the good is a luxury necessities tend to have an inelastic demand whereas luxuries tend to have a more elastic demand. The proportion of a consumers income allocated to spending on the good products that take up a high % of income will have a more elastic demand The time period allowed following a price change demand is more price elastic, the longer that consumers have to respond to a price change. They have more time to search for cheaper substitutes and switch their spending. Whether the good is subject to habitual consumption consumers become less sensitive to the price of the good of they buy something out of habit (it has become the default choice). Peak and off-peak demand- demand is price inelastic at peak times and more elastic at off-peak times this is particularly the case for transport services. The breadth of definition of a good or service if a good is broadly defined, i.e. the demand for petrol or meat, demand is often inelastic. But specific brands of petrol or beef are likely to be more elastic following a price change.

Income elasticity of demand:

In economics, the income elasticity of demand measures the responsiveness of the quantity demanded of a good to the change in the income of the people demanding the good. It is calculated as the ratio of the percent change in quantity demanded to the percent change in income. For example, if, in response to a 10% increase in income, the quantity of a good demanded increased by 20%, the income elasticity of demand would be 20%/10% = 2.

Examples: Income elastic - Organic bread.If income increases people may switch to the luxury option of organic bread. Income inelastic - An inferior good has a negative income elasticity of demand. When incomes increase, demand falls. Instant coffee. Instant coffee is cheap, if income goes up, you may buy takeaway or switch to filter coffee.

Cross elasticity of demand:

In economics, the cross elasticity of demand and cross price elasticity of demand measures the responsiveness of the quantity demand of a good to a change in the price of another good.It is measured as the percentage change in quantity demanded for the first good that occurs in response to a percentage change in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the quantity of new cars that are fuel inefficient demanded decreased by 20%, the cross elasticity of demand would be -20%/10% = -2.Substitute goodsFor goods which are substitutes, we expect to see a positive cross elasticity of demand. If the price of Britannia bread increases, people will buy more of an alternative, such as Modern bread. Weak substitutes like tea and coffee will have a low cross elasticity of demand Alternative brands of chocolate, e.g. Dairy Milk vs Nestle are quite similar, so will have a higher cross elasticity of demand.

Complements goodsThese are goods which are used together, therefore the cross elasticity of demand is negative. If the price of one goes up, you will buy less of both goods. For example, if the price of DVD players goes down, you will buy more DVD players and also there will be an increase in demand for DVD disks. If the price of Samsung mobile phones goes down, we will also buy more Samsung related phone accessories.

What is Giffens Paradox?According to the Law of Demand, when the price of a commodity falls the demand for it rises. Giffen's Paradox is an exception to this law. It is named after the 19th century British economist, Sir Robert Giffen, who found that when the price of bread fell, the demand for it also fell. This was because when the price fell, the real income of the consumer rose and she / he were in a position to buy better quality/more bread.

What is Veblen effect?Veblen goods have a positive sloping demand curve. This means that as greater the price of the product, as greater the demand.This often happens withluxury productssuch as Rolex watches, a prime quality wine or Rolls-Royce cars. A decrease in the prices of such goods could make them lose their exclusivity and status. Clients strongly appreciate the fact that the goods they consume are only affordable for a small part of the population.