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Price elasticity of demand (PED)
A measure of the resposniveness of the demand for a product to changes in its own price.
PED - formula
Price elasticity of demand is calculated and defined as:
Price elasticity of demand = % change in Qd / % change in P
Where Qd = Quantity demanded
and P = Price
Some students find it difficult to remember which way up this equation is. The following 'aide memoire' may be of use. You usually put your dinner (demand) on your plate (price). Demand is over price, D over P!
Price elasticity is negative because price and quantity demanded usually vary inversely with each other. This is so common that the sign is ignored. Do not forget, when price increases, demand falls and vice versa.
Elasticity values
Elasticity ranges from zero to infinity and the value is given different names over different numerical ranges as summarised in the table below.
| PERFECTLY INELASTIC | Price has no effect on demand at all |
| INELASTIC | Price has a small effect on demand. The % change in price is larger than the % change in demand |
| UNITARY | % Change in price and % change in demand are the same. Remember, though, the signs are different. |
| ELASTIC | Demand is very sensitive to price. The % change in price is less than the % change in demand. |
| PERFECTLY ELASTIC | An infinite amount is demanded at one price but nothing at all at a slightly higher price. |
Elasticity along a straight line demand curve
Because of the way that it is calculated, price elasticity will vary along a straight - line demand curve. Examine Figure 1 carefully.
Figure 1 Elasticity along a straight-line demand curve
It is usual to represent the degree of elasticity graphically. The common shapes for demand curves and their elasticity values are given in the diagrams below.
Figure 2 Perfectly inelastic demand curve
Figure 3 Inelastic demand curve
Figure 4 Elastic demand curve
Figure 5 Perfectly elastic demand curve
The special shape that represents a price elasticity of 1 is known as a rectangular hyperbola! This is shown below.
Figure 6 Unit elastic demand curve
Determinants of price elasticity
Price elasticity of a good or service depends on a range of factors:
- The availability of close substitutes in the market. The more substitutes available the greater the elasticity.
- Is the good a luxury or necessity? Luxuries are more elastic in demand than necessities.
- Proportion of income spent on them. Cheap items tend to have an inelastic demand.
- Are they addictive? These obviously become price inelastic.
- The time period. Elasticity tends to increase with time.
- Number of uses
For more detail on any of these factors, follow the links above.
You will be expected to calculate and use elasticity, and to interpret given data. This may happen in any of the papers that are taken. Some examples follow (click on the example links) and there are a series of practice questions which are accessible from the questions section (click on questions - module 2 in the left-hand menu bar).
Example 1 - price elasticity of demand
Example 2 - price elasticity of demand
Elasticity and revenue
Remember that if demand for a good or service is price inelastic then an increase in price will decrease sales but increase sales revenue. However, a price cut will increase both sales but decrease sales revenue.
Firms like the demand for their product if possible to be inelastic. This means that any increase in price that they put in place will have proportionately less of an effect on demand and their total revenue will rise.
If price elasticity is 1, then revenue is the same all the time, even if prices are increased or decreased.
The changes in revenue for different elasticity values are summarised in the table below.
| Elastic | Increase | Fall | Elastic demand will mean that when price increases, demand will fall by a greater percentage than the price increased. This means a fall in revenue. |
| Elastic | Decrease | Increase | Elastic demand will mean that when price falls, demand will increase by a greater percentage than the price decreased. This means an increase in revenue. |
| Inelastic | Increase | Increase | Inelastic demand will mean that when price increases, demand will fall by a smaller percentage than the price increased. This means an increase in revenue. |
| Inelastic | Decrease | Fall | Inelastic demand will mean that when price falls, demand will increase by a smaller percentage than the price decreased. This means a fall in revenue. |