What is price elasticity of demand, and how can it affect the decisions of retailers?

Price Elasticity of Demand refers to the extent to which demand for a product will change in response to a change in its price.

If PED is 'elastic' this means that any given change in price will result in a more than proportionate change in demand.

If PED is 'inelastic' this means that any given change in price will result in a less than proportionate change in demand.

For example, let's say a retailer changes the price of oranges, from £1 to £1.50. As a result, the demand for oranges over the next week falls from 1000 to 850.

We can calculate that the change in price has been 50% (50/100 x 100 = 50) and that change in demand, in response to this, has been (-)15% (150/1000 x 100 = 15). The percentage change in demand has thus been smaller than the percentage change in price, meaning we can describe the PED of oranges, in this case, as inelastic.

Indeed, we can work out the 'coefficient' for elasticity using the formula '% change in demand / % change in price'. So, demand has changed by 15%, and price by 50%: 15/50= 0.3. Any figure less than 1 represents an inelastic PED; a figure equal to 1 represents unit elasticity (changes in demand are equal to changes in price); a figure greater than 1 represents an elastic PED.

How, then, might the PED of a product affect the decisions of a retailer? Let's take the example of our oranges. We saw that oranges had an 'inelastic' PED, which meant an increase in price was met with a less than proportionate decrease in demand.

At £1 each, the retailer sold 1000 oranges, making £1000 in return.

At £1.50 each, the retailer sold 850 oranges, and this makes £1275 in return.

Therefore, we can say that if a product appears to have an inelastic PED, it makes sense to increase the price, as this will result in a greater return, and vice versa.