2.6. Price elasticity of demand (PED)
- Syllabus
- 0455–2027–2028
- Topic
- 2.6
- Level
- —
Learning objectives
2.6.1Definition of PED• Definition of PED2.6.2Calculation of PED• calculation of PED using the formula• interpretation of the significance of the PED value: perfectly inelastic, inelastic, unitary, elastic, perfectly elastic• drawing and interpretation of demand curve diagrams to show different PED2.6.3Determinants of PED• main influences on whether demand is elastic or inelastic2.6.4PED, consumer expenditure and firms’ revenue• effect of price changes on the amount spent by consumers and revenue raised by firms, shown both in a diagram and as a calculation• relationship between PED and the amount spent by consumers and revenue raised by firms2.6.5Significance of PED• implications of PED for decision-making by consumers, workers, producers/firms and government
Measure price responsiveness with PED
Price elasticity of demand (PED) measures how responsive quantity demanded is to a change in the product's own price, with other demand conditions unchanged.
PED compares percentage changes, so it can compare responsiveness across products measured in different units. A large response in quantity relative to the price change means demand is price-elastic; a small response means demand is price-inelastic.
For a normal downward-sloping demand curve, price and quantity demanded move in opposite directions, so the calculated PED is negative. When classifying responsiveness, economists usually compare its magnitude, ∣PED∣, with 1.
PED concerns movement along a demand curve caused by the product's own price. A change in income, tastes or the price of another good shifts demand and is not the price change measured by PED.
Calculate and classify PED
PED = \frac{%\ change\ in\ quantity\ demanded}{%\ change\ in\ price}
Calculate each percentage change from its original value, then divide the quantity percentage by the price percentage. Example: price rises by 5% and quantity demanded falls by 4%, so PED=−4%/5%=−0.8. Its magnitude is 0.8, therefore demand is price-inelastic.
| PED magnitude | Interpretation | Demand-curve form |
|---|---|---|
| 0 | perfectly inelastic: quantity does not respond | vertical |
| between 0 and 1 | inelastic: quantity changes by a smaller percentage | relatively steep over a comparable range |
| 1 | unitary: equal percentage changes | rectangular hyperbola if unitary throughout |
| greater than 1 | elastic: quantity changes by a larger percentage | relatively flat over a comparable range |
| ∞ | perfectly elastic: any price rise reduces quantity demanded to zero | horizontal |
The formula can also recover a quantity response: if PED=−1.7 and price falls by 5%, quantity demanded changes by (−1.7)×(−5%)=+8.5%. The two negative changes produce a positive quantity response.
Do not classify from a curve's apparent steepness unless axes and scales are comparable. Slope uses absolute changes; PED uses percentage changes and may vary along one straight demand curve.
Explain what determines PED
Demand is more price-elastic when consumers can change their purchasing plans easily after a price change. It is more inelastic when avoiding or replacing the purchase is difficult.
| Influence | More elastic when... | Why quantity responds more |
|---|---|---|
| substitutes | close alternatives are available | consumers can switch |
| necessity or luxury | the product is a luxury | purchase can be reduced or avoided |
| share of income | the purchase takes a large share | the price change matters more to the budget |
| postponement | purchase can be delayed | consumers can wait or search |
| time | more adjustment time is available | alternatives and habits can change |
| market definition | the product is narrowly defined | more substitutes exist for a brand than for the whole category |
| habit and loyalty | habit or brand loyalty is weak | switching is easier |
A particular luxury-chocolate brand is likely to have more elastic demand than salt: other brands can substitute for it, it is less necessary, its purchase can be postponed and it may take a larger share of income. Salt as a broad, low-cost necessity has fewer close alternatives.
These are influences, not guarantees. Several determinants operate together, so the final PED depends on the product, consumers, market definition and time period being analysed.
Link PED to expenditure and revenue
Consumer\ expenditure = Firm\ revenue = Price\times Quantity\ sold
On a demand diagram, expenditure or revenue is the rectangle with height equal to price and width equal to quantity demanded. Compare the original P1×Q1 rectangle with the new P2×Q2 rectangle after a movement along the demand curve.
| PED magnitude | If price rises | If price falls |
|---|---|---|
| elastic, ∣PED∣>1 | revenue/expenditure falls | revenue/expenditure rises |
| unitary, ∣PED∣=1 | unchanged | unchanged |
| inelastic, ∣PED∣<1 | revenue/expenditure rises | revenue/expenditure falls |
Suppose price falls from 10to8 while sales rise from 100 to 140 units. Revenue changes from 10×100=1000 to 8×140=1120. Quantity rose proportionately more than price fell, so demand was elastic over this change and the price cut increased revenue.
With elastic demand, the proportionate quantity response dominates the price change. With inelastic demand, the price change dominates the smaller quantity response. At unitary elasticity, the two percentage effects offset.
Revenue is not profit: profit also depends on costs. This relationship assumes the price change causes movement along the same demand curve; a simultaneous demand shift prevents PED alone from explaining the revenue change.
Use PED in economic decisions
PED helps decision-makers predict how strongly sales will respond to a price change. The prediction supports a decision; it does not determine the decision on its own.
| Decision-maker | PED implication | Decision use |
|---|---|---|
| consumers | an inelastic essential has a small quantity response, so a price rise can increase spending on it | plan budgets or search for substitutes where possible |
| workers | elastic market demand can make a price rise produce a relatively large fall in sales | anticipate possible changes in output and labour demand, while recognising other factors also affect jobs |
| producers/firms | lowering price raises revenue when demand is elastic; raising price raises revenue when demand is inelastic | choose prices and forecast sales, output and revenue |
| government | inelastic demand gives a smaller fall in taxed quantity; elastic demand gives a larger behavioural response | assess indirect-tax or tariff revenue and how strongly consumption or imports may fall |
A government seeking reliable revenue may prefer to tax a product with relatively inelastic demand, because quantity bought falls by a smaller percentage. If its priority is a large reduction in consumption or imports, a more elastic response makes a given price increase more powerful, although tax revenue then depends on the size of the quantity fall.
PED alone cannot predict profit, employment or tax revenue exactly. Costs, supply conditions, the size of the tax or price change, time, enforcement and changing demand conditions also matter.