The price elasticity of demand is the way the quantity of goods demanded responds to a change in the price of the particular good or service. It is the measure of the quality's responsiveness in terms of the amount demanded due to a change in price, all factors held constant. The value of this elasticity is given as a ratio and the higher the magnitude the higher the elasticity. Therefore, price a change upward will mostly lead to a decrease in the quantity of goods or services demanded whereas a change downwards or a decrease in price would lead to an increase in quantity of the goods demanded (Tutor2u, 2010).
The Price elasticity of demand plays a very significant role in the determination of a firm's profit and revenue across the business duration. It illustrates ways in which the demand of a given good or service offered by the firm is going to change for a specific change in price and ultimately how it will affect its gains.
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If the change is negative, meaning the price change results in less demand and the total worth of the demand may not measure up to the expected profit; then this analysis can be used to indicate the profit and hence revenue expected from the sell of those goods and services, at that price. Since the major purpose of a firm is to maximize profits and total revenue which is profit less total cost, the value of elasticity becomes an important tool for identifying the effects on the firm's total revenue at the end of the business duration. If the PED is quite inelastic for example at a given price (say PED=0.2), then total revenue increases because the price is larger in proportion than the decrease in quantity. If however on the other hand the PED is elastic at a given price, then it implies that by proportion, the increase in price is smaller compared to the drop in demanded quantity. In such a scenario, the profit of the firm and hence total revenue will decrease (Bized, 2010).