The Significance of PED (CIE IGCSE Economics)

• 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 & decrease prices on products that are elastic in demand 

• This can be illustrated using a demand curve

An illustration of price elastic demand where a small decrease in price from P₁→P₂ causes 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
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An illustration of price inelastic demand where a large increase in price from P₁→P₂ causes 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
  • 

Step 1: Calculate the initial sales revenue

Step 2: Calculate the sales revenue after the price change

Step 3: Explain the decision

By raising the price, the total revenue has fallen by £400. This indicates that the product is price elastic in demand and the firm should have lowered their price in order to maximise revenue

• 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