Price Elasticity of Demand (PED) (Copy)
2.7 Price Elasticity of Demand (PED)
2.7.1 Definition of PED
- PED = Measures the responsiveness of demand to a change in price.
- Types of elasticity:
- Elastic demand: PED > 1 (demand responds a lot).
- Inelastic demand: PED < 1 (demand responds little).
- Unitary elasticity: PED = 1 (demand changes in exact proportion to price).
- Perfectly inelastic: PED = 0 (demand does not change at all).
- Perfectly elastic: PED = ∞ (demand drops to zero if price rises at all).
2.7.2 Calculation of PED
Formula:
PED = (% change in Quantity Demanded) ÷ (% change in Price)
- PED values are usually negative (because of inverse relationship), but in exams we take the absolute value.
Examples:
- Price rises 10%, demand falls 20% → PED = 20 ÷ 10 = 2 (Elastic).
- Price rises 20%, demand falls 5% → PED = 5 ÷ 20 = 0.25 (Inelastic).
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course
2.7.3 Determinants of PED
| Determinant | Effect on Elasticity | Example |
|---|---|---|
| Substitutes | More substitutes → demand more elastic | Coke vs Pepsi |
| Proportion of income | Higher % of income → more elastic | Cars vs chewing gum |
| Necessity vs luxury | Necessities = inelastic, Luxuries = elastic | Bread vs designer clothes |
| Time period | Longer time → demand becomes more elastic | Petrol short run inelastic, long run elastic |
| Habit-forming goods | Addictive goods = inelastic | Cigarettes |
2.7.4 PED and Total Spending / Revenue
- Total Revenue (TR) = Price × Quantity.
- Relationship:
| Demand Type | If Price ↑ | If Price ↓ |
|---|---|---|
| Elastic (PED > 1) | TR decreases | TR increases |
| Inelastic (PED < 1) | TR increases | TR decreases |
| Unitary (PED = 1) | TR unchanged | TR unchanged |
Examples:
- Elastic demand: Airlines cut ticket prices → TR increases.
- Inelastic demand: Cigarette tax increases → TR rises.
Diagram tip:
- On a demand curve:
- Upper half = Elastic.
- Lower half = Inelastic.
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course
2.7.5 Significance of PED
- Consumers: Helps understand how spending changes when prices move.
- Producers:
- Raise prices when demand is inelastic.
- Cut prices when demand is elastic.
- Government:
- Place indirect taxes on inelastic goods (petrol, tobacco).
- Subsidise elastic goods if they want to encourage demand.
Quick Exam Examples
- Petrol → inelastic → tax increase raises government revenue.
- Designer bags → elastic → firms cut prices to boost sales.
- Bread → inelastic → price increase raises supplier revenue.
- Holiday trips → elastic → lower price increases airline revenue.
Memory Hooks
- Formula: PED = %ΔQ ÷ %ΔP.
- Elastic = sensitive, Inelastic = insensitive.
- Revenue Rule:
- Elastic → Price and TR move in opposite directions.
- Inelastic → Price and TR move in same direction.
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Economics Full Scale Course