[1.1.4a] Price elasticity of demand
Price Elasticity of Demand (PED)
Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its price. It tells us whether consumers react strongly or weakly when a price changes — information that is vital for businesses setting prices and governments designing tax policy.
PED = % change in quantity demanded ÷ % change in price
Because price and quantity demanded move in opposite directions (the law of demand), PED values are almost always negative. By convention, economists often refer to the absolute value — so a PED of −0.5 is described as "0.5" in everyday usage, though the negative sign is important for interpretation.
Calculating PED: Worked Example
Worked Example
Scenario: The price of a cinema ticket rises from £8.00 to £10.00. Weekly admissions fall from 500 to 400.
PED = % change in Qd ÷ % change in P
- % change in Qd = ((400 − 500) ÷ 500) × 100 = −20%
- % change in P = ((10 − 8) ÷ 8) × 100 = +25%
- PED = −20 ÷ 25 = −0.8
Interpreting PED Values
| PED Value | Label | Meaning | Example |
|---|---|---|---|
PED = 0 | Perfectly inelastic | Quantity demanded does not change at all when price changes | Insulin for diabetics |
0 > PED > −1 | Price inelastic | A 1% price change causes less than 1% change in Qd | Petrol, cigarettes, salt |
PED = −1 | Unitary elastic | A 1% price change causes exactly 1% change in Qd | Theoretical benchmark |
PED < −1 | Price elastic | A 1% price change causes more than 1% change in Qd | Luxury cars, foreign holidays |
PED = −∞ | Perfectly elastic | Any price rise reduces quantity demanded to zero | Identical commodities in perfect competition |
Factors Influencing PED
- Availability of substitutes: goods with many close substitutes have elastic demand — if price rises, consumers switch. Goods with few substitutes (e.g. petrol) tend to be inelastic.
- Degree of necessity: essential goods such as medicines have inelastic demand because consumers must buy them regardless of price. Luxury goods are more elastic.
- Proportion of income spent: goods taking up a large share of income (e.g. a car) tend to have more elastic demand — consumers think carefully before buying. Goods costing little relative to income tend to be inelastic.
- Time: demand becomes more elastic over time as consumers find substitutes, change habits or invest in alternatives. In the short run, consumers may have no immediate option and continue buying despite a price rise.
PED and Total Revenue
Total revenue (TR) = Price × Quantity. Whether a price change raises or lowers TR depends entirely on PED.
When demand is elastic (PED < −1): a price rise causes a proportionally larger fall in Qd, so TR falls. A price cut causes TR to rise.
Worked Example
Scenario: Price of a luxury watch falls from £500 to £400. Quantity sold rises from 100 to 160. (PED = −3)
- Original TR = £500 × 100 = £50,000
- New TR = £400 × 160 = £64,000
When demand is inelastic (0 > PED > −1): a price rise causes a proportionally smaller fall in Qd, so TR rises. A price cut causes TR to fall.
Worked Example
Scenario: Price of cigarettes rises from £10 to £12 per pack. Quantity sold falls from 1,000 to 900. (PED = −0.5)
- Original TR = £10 × 1,000 = £10,000
- New TR = £12 × 900 = £10,800
When demand is unitary elastic (PED = −1): the proportional change in Qd exactly equals the proportional change in price, so TR is unchanged whether price rises or falls.
Worked Example
Scenario: Price rises 10%; Qd falls 10%.
- Original TR = £20 × 500 = £10,000
- New TR = £22 × 450 = £9,900 (approximately unchanged)
Key Takeaways
- PED = % change in Qd ÷ % change in P. Values are almost always negative.
- Values between 0 and −1 = inelastic; values below −1 = elastic.
- Key factors: substitutes, necessity, share of income and time.
- Inelastic demand: raising price increases TR. Elastic demand: raising price decreases TR.
- Governments target goods with inelastic demand for indirect taxes — revenue is higher and quantity reduction is smaller.