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

Defining and calculating 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

Calculating PED

• PED can be calculated using the following formula:

• To calculate a % change, use the following formula:

Interpreting PED values

• The results of the price elasticity of demand calculation tell us how responsive consumers are to a change in price

1. Price elastic demand

• The value of PED: -1 → ∞

• The percentage change in quantity demanded is more than proportional to the percentage change in price

• Consumers are very responsive to price changes

  • For example, a small price cut on airline tickets in Malaysia can lead to a large rise in bookings

2. Price inelastic demand

• The value of PED: 0 → -1

• The percentage change in quantity demanded is less than proportional to the percentage change in price

• Consumers are relatively unresponsive to price changes

  • They may consider the product to be a necessity

• For example, cigarette sales in Indonesia fall only slightly when prices rise – demand is inelastic

3. Perfectly elastic demand

• The value of PED: ∞

• The quantity demanded will fall to zero with any percentage change in price (highly theoretical elasticity)

• Buyers will only purchase at one price, and any change causes demand to drop to zero

• For example, on global stock markets, traders may only buy a share at a specific price, not higher

4. Perfectly inelastic demand

• The value of PED: 0

• The quantity demanded is completely unresponsive to a change in price (very theoretical value)

• For example, a patient needing life-saving insulin in India will buy it regardless of price

5. Unitary elasticity

• The value of PED: 1

• The percentage change in quantity demanded is exactly equal to the percentage change in price

• A 5% rise in the price of a basic mobile plan in Egypt causes a 5% drop in subscriptions

The determinants of PED

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

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

S – Availability of substitutes

• Good availability of substitutes results in a higher value of PED (relatively elastic)

P – 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)

L – Luxury or necessity

• Luxury goods are more elastic because they are not essential, while necessities are more inelastic because consumers have no choice but to buy them.

A - Addictiveness of the product

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

T – 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)

Variation in PED along a straight-line curve

• PED varies along the length of a straight-line demand curve

• The slope is constant, but elasticity changes

Diagram analysis

Top of the demand curve

• Demand is price elastic

• PED > 1

• Small price changes cause large percentage changes in quantity demanded

Middle of the demand curve

• Demand is unit elastic

• PED = 1

• Percentage change in price equals percentage change in quantity demanded

Bottom of the demand curve

• Demand is price inelastic

• PED < 1

• Price changes cause relatively small percentage changes in quantity demanded