Elasticity

Price Elasticity of Demand

Learning outcomes:

Explain the concept of Price Elasticity of Demand.

Calculate PED.
Why PED is always negative.
Explain using diagrams, PED values, elastic demand,
inelastic demand, unit elastic demand, perfectly elastic
demand and perfectly inelastic demand.
Explain the determinants of PED
Calculate the PED between two designated points.
Explain why PED varies along a straight line demand
curve.

Elasticity
The study of elasticity examines the
responsiveness of consumers or producers to a
change in a variable in the marketplace.

Implications for businesses:

How consumers react to price changes has
major implications on businesses when they
are considering increasing or decreasing
prices.
Producers need to understand how changes
in prices of other goods will affect the market
demand for their products. (Ex. Toyota
expanding production of their hybrid cars).

Implications for Governments

Governments must consider elasticities
when considering what goods to place a tax
on. If consumers are highly responsive to
price change for a specific good, placing a
tax on the product will garner little tax
revenue.

Price Elasticity of Demand

PED: measures the responsiveness or
sensitivity of consumers to the change in price
of a particular product.
In other words...if the price of a good increases
by $1, how much will the Quantity Demanded
decrease.

Formula
Yes, you must know this.
PED = %change Quantity Demanded
_________________________________________________________________________________________________________________________

%change Price
To calculate % change:

new - old X 100

--------------------------------------------------------------

old

Try this.
Luxury SUV retails for 40,000 pounds in the UK
in July. 7,000 SUVs are sold.
In August, the vehicle is marked down to
37,000 pounds and 7,200 SUVs are sold.
Calculate the PED for SUVs.

Steps
1.

Calculate the % change in Quantity and Price.

% change calculation

Price

Quantity

New

37,000

7,200

Old

40,000

7,000

37,000 - 40,000
------------------------------------------------------------------------------------

40,000

-0.075 or -7.5% in Price

Calculating % Change in Quantity

Demanded
7,200 - 7,000

0.029 or 2.9%

-----------------------------------------------------------------------------------------

7,000
So, % change in Price is -7.5%
% change in Quantity Demanded is 2.9%

Calculate the PED

PED = % change in Qd
--------------------------------------------------------------------------------------------------------------

% change in Price
PED = 2.9%

PED = -0.36

--------------------------------------

-7.5%
PED will always be negative because of the inverse relationship between Price and Quantity. You will
always take the absolute value when interpreting the number.

What does this number mean.

We know that a decrease in the price of SUVs
by 7.5% that the Quantity Demanded (sold)
increased by 2.9%.
PED = .36 tells us.
For every 1% decrease in price, the Quantity
Demanded increased by .36%

Interpreting PED
PED < 1
1. Consumers a less
sensitive to price changes
2. % increase in Price > %
decrease in Quantity
3. Closer to 0 the PED is,
the less sensitive
consumers are to price
changes.

Interpreting PED
PED > 1
1. Consumers are more
sensitive to price changes.
2. % change in Price < %
change in Quantity
Demanded.
3. The larger the number, the
more sensitive the consumer
is to a change in Price.

More.
PED = 1

Unit Elastic

% change in Price is equal to the % change in Quantity

Demanded

PED = 0

Perfectly Inelastic Demand

Any change in Price is met with no change in Quantity

Demanded

PED = infinity Perfectly Elastic Demand

Any change in price leads to an infinite change in Quantity
Demanded