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.

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.

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?

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:

\(\hbox{PED}=\frac{\hbox{% Change in Quantity Demanded}}{\hbox{& Change in Price}}\)

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:

Demand also tends to be elastic for luxury goods.

|PED| = 1: if the absolute value of PED is equal to one, it means that demand is unitary.

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.

FIg. 1 - Interpreting PED

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.

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

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

Fig. 2 - Interpreting YED

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.

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 with a selection of higher-end consumer goods.