Price Elasticity of Demand

Price elasticity of demand
Economics
Agenda
Understand how to define and calculate price elasticity of demand (PED)
Understand how to use diagrams to show price elastic and price inelastic demand
Understand how to interpret numerical values for PED
Understand the factors that influence PED
Understand the relationship between PED and total revenue following price
changes
Introduction
We discussed that a price change will result in a movement along the demand
curve. For example, if a price falls, there will be an increase in the quantity
demanded.
However, price changes can bring about different responses in the quantity
demanded. The demand for some goods changes more than others when prices
change.
What is price elasticity of
demand?
For some goods, a price change will result in a large change

in the quantity demanded and for others a smaller change.
It all depends on the type of good.
The demand curve for product A is steep and the demand
curve for product B is flatter. The quantity demanded shows
a different response to a change in price.
Demand for product B is more responsive to the price
change. This relationship between the responsiveness of
demand to a change in price is called price elasticity of
demand.
Price elasticity of demand the responsiveness of demand
to a change in price
Price inelastic and
price elastic demand
In the graph, for product A, the price change resulted

in a small change in demand. The change in demand
was not as big as the change in price. When this
happens, economists say that the good has inelastic
demand or that demand is price inelastic. A minority
of goods have inelastic demand.
In the graph, for product B, the price change resulted
in a significant change in the quantity demanded. This
means the change in demand was greater than the
change in price. When this happens, economists say
that the good has elastic demand or that demand is
price elastic. Goods with elastic demand are more
responsive to price changes.
Calculating the price
elasticity of demand
It is possible to calculate the price elasticity of demand (PED) of a
good using the formula shown below.
For product A, when price falls from 10 to £8, the PED would be:
For product B, when price falls from 10 to £8, the PED would be:
Interpreting the numerical values of elasticity
• perfectly elastic demand
The values show whether demand is price elastic or price
where PED = ∞ (an increase
inelastic.
in price will result in zero
If the value of PED is less than 1 (that is, a fraction or a decimal), demand)
demand is said to be inelastic. Demand for product is price
• perfectly inelastic demand
inelastic because price elasticity is –0.5.
where PED = 0 (a change in
If the value of PED is greater than 1, demand is said to be elastic. price will result in no change
Demand for product B is price elastic because price elasticity is – in the quantity demanded)
2.5.
• unitary elasticity where PED
If the value of PED is zero, demand is said to be perfectly = –1 (the responsiveness of
inelastic. demand is proportionately
If PED is equal to infinity (∞), demand is said to be perfectly equal to the change in price)
elastic.
If PED is exactly -1, demand is said to have unitary elasticity.
Price elasticity and the slope of the
demand curve
There are some special cases where PED is either 0,

infinite or equal to –1.
The vertical demand curve shows the demand curve for
a good that has perfectly inelastic demand. This means
that a price change will not affect the quantity
demanded.
For example, if the price increases from p1 to p2, there
is no change in the quantity demanded, it remains at
q1. The value of price elasticity in this case is zero.
Price elasticity and the slope of the
demand curve
The horizontal demand curve shows a demand curve

for a good that has perfectly elastic demand. This
means that buyers purchase as much as they possibly
can at price p1.
However, if the price rises above p1, the quantity
demanded will fall to zero. The value of price elasticity
in this case is infinite.
Price elasticity and the slope of the demand
curve
The demand curve in shows the shape of a demand
curve where PED = –1.
This is a special case in economics and when there is a
price change the effect on total revenue is unique.
When the price is 10, the quantity demanded is 50 units
and total revenue is 500 (£10 × 50).
Alternatively, when the price is 5, the quantity
demanded is 100 units and total revenue is still 500 (5 ×
100).
When demand has unitary elasticity the total revenue
will be exactly the same at every price. Therefore, a
price change will result in no change in total revenue.
Factors affecting price elasticity of demand
Availability of substitutes Degree of necessity
Goods that have lots of close substitutes will Goods considered ‘essential’ by consumers will
tend to have elastic demand, because have inelastic demand.
consumers can switch easily from one product In contrast, goods that are not essential – for
to another.
example, luxury products, such as boats, sports
In contrast, if there are few or no real cars and holidays – will have more elastic
substitutes for a product, demand will be demand.
inelastic.
Factors affecting price elasticity of demand
Proportion of income spent on a Time
product
Products that cost a lot in relation to income, In the short term, goods have inelastic demand
tend to be elastic. because it can often take time for consumers to
In contrast, demand for products that cost very find substitutes when the price rises,
little in relation to income – for example, In the long term, demand is more elastic
stamps or pencils – are more price inelastic. because consumers can search for alternatives
and are more prepared to switch.
The relationship between PED and total revenue
The value of PED shows whether revenue

will rise or fall following a price change.
Consider the example mentioned above.
For product A, when the price falls from 10
to 8, the quantity demanded increases from
100 to 110 units. Total revenue will change.
When P = 10 TR = 10 × 100 = 1000
When P = 8 TR = 8 × 110 = 880
For product B, when the price falls from 10
to 8, the quantity demanded rises from 100
to 150 units.
When P = 10 TR = 10 × 100 = 1000
When P = 8 TR = 8 × 150 = 1200
Price elasticity of demand
End of chapter

Price Elasticity of Demand

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Price elasticity of demand

For some goods, a price change will result in a large change

In the graph, for product A, the price change resulted

There are some special cases where PED is either 0,

The horizontal demand curve shows a demand curve

Availability of substitutes Degree of necessity

The value of PED shows whether revenue

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