Price Elasticity of Demand (PED) (AQA A Level Economics): Revision Note

The Definition & Calculation of PED

• The law of demand states that when there is an increase in price, there will be a fall in the quantity demanded

  • Economists are interested by how much the quantity demanded will fall

• Price elasticity of demand reveals how responsive the change in quantity demanded is to a change in price

  • The responsiveness is different for different types of products

Calculation of PED

• PED can be calculated using the following formula
  

$\text{PED = }\frac{\%\mathrm{change}\mathrm{in}\mathrm{quantity}\mathrm{demanded}}{\%\mathrm{change}\mathrm{in}\mathrm{price}}=\frac{\%△\mathrm{in}\hspace{0.17em}\mathrm{QD}}{\%△\mathrm{in}\mathrm{P}}$

• To calculate a % change, use the following formula
  

$\%\mathrm{Change}=\frac{\mathrm{new}\mathrm{value}-\mathrm{old}\mathrm{value}}{\mathrm{old}\mathrm{value}}\times 100$ 

Interpreting PED Values

PED Classifications

Value	Name and Diagram	Explanation
0	Perfectly Inelastic	The QD is completely unresponsive to a change in P (very theoretical value e.g. heart transplant is extremely inelastic but possibly not perfectly)
0 →1	Relatively Inelastic	The %∆ in QD is less than proportional to the %∆ in P (e.g. addictive products)
1	Unitary Elasticity	The % ∆ in QD is exactly equal to the %∆ in P
1 → ∞	Relatively Elastic	The %∆ in QD is more than proportional to the %∆ in P (e.g. luxury products)
∞	Perfectly Elastic	The %∆ in QD will fall to zero with any %∆ in P (highly theoretical elasticity)

PED & Total Revenue

• Knowledge of PED is important to firms seeking to maximise their revenue

• Sales revenue will be maximised 

  • If their product is price inelastic in demand, they should raise their prices

  • If their product is price elastic in demand, then they should lower their prices

• This rule is used when firms choose to use price discrimination to maximise their revenue

  • They lower their prices for elastic sections of their market e.g. off peak train travel

  • They increase prices for inelastic sections of their market e.g. peak hour train travel

• The benefits of this rule can be illustrated using a demand curve

  • A shallow curve represents a price-elastic product

  • A steep curve represents a price inelastic product

Diagram: Elastic Demand Curve 

Diagram analysis

• When a good/service is price elastic in demand, there is a greater than proportional increase in the quantity demanded to a decrease in price

  • A small decrease in price leads to a larger increase in QD

• TR is higher once the price has been decreased

  • $({\mathrm{P}}_2\times {\mathrm{Q}}_2)>({\mathrm{P}}_1\times {\mathrm{Q}}_1)$

Diagram: Inelastic Demand Curve 

Diagram analysis

• When a good/service is price inelastic in demand, there is a smaller than proportional decrease in the quantity demanded to an increase in price

  • A large increase in price leads to a smaller decrease in QD

• TR is higher once the price has been increased

  • $({\mathrm{P}}_2\times {\mathrm{Q}}_2)>({\mathrm{P}}_1\times {\mathrm{Q}}_1)$
    

The Factors that Influence PED

• Some products are more responsive to changes in prices than other products

• The factors that determine the responsiveness are called the determinants of PED and include:

  • Availability of substitutes: good availability of substitutes results in a higher value of PED (relatively elastic)

  • Addictiveness of the product: addictiveness turns products into necessities, resulting in a low value of PED (relatively inelastic)

  • Price of product as a proportion of income: the lower the proportion of income the price represents, the lower the PED value will be. Consumers are less responsive to price changes on cheap products (relatively inelastic)

  • Time period: In the short term, consumers are less responsive to price increases, resulting in a low value of PED (relatively inelastic). Over a longer period of time, consumers may feel the price increase more and will then look for substitutes, resulting in a higher value of PED (relatively elastic)