What is Price Elasticity of Demand
Price elasticity of demand or PED is used to measure the relationship between a change in the quantity demanded of a good and a change in the price of the good.
Equation
% Change (∆) in Demand of Good X % ∆ in Price of Good X
How to Calculate PED
Step-by-Step Guide:
- First calculate the percentage change in quantity demanded - (New quantity minus Old Quantity / Old Quantity) x 100
- Calculate percentage change in price - (New price minus Old price / Old price) x 100
- Divide percentage change in quantity by percentage change in price - Remember to include minus signs
Example:
A publishing company reduces magazine prices from £1.00 to 90p. Daily demand for magazines rises from 100,000 to 120,000.
What is the PED (to one decimal place)?
- Percentage Change in Demand: (120,000 - 100,000 / 100,000) x 100 = 20
- Percentage Change in Price: (1 - 0.9 / 0.9) x 100 = 11.1
- Divide Demand by Price: 20 / 11.1
- Answer = 1.8
Values
PED > 1 = Price Elastic
When PED for a good is greater than 1 it is said to be price elastic. In other words, a change in price causes an even greater change in quantity demanded.
PED < 1 = Price Inelastic
When PED for a good is less than 1, it is price inelastic. A change in price causes a proportionally smaller change in quantity demanded. Put simply, a change in price doesn't have much of an effect on demand. Consider addictive goods such as cigarettes, when price changes this is unlikely to change demand for cigarettes because people who are addicted will still purchase to goods.
PED = 1 = Unitary Price Elastic
If PED is equal to 1 then demand is unit elastic, demand changes exactly in proportion with price. For example a 10% increase in price would lead to a 10% contraction in demand.
PED = 0 = Perfectly Inelastic
A good with a PED of 0 is said to be perfectly inelastic, a change in price has no effect on demand. In this case the demand curve is vertical, this is because demand does not change at all when the price changes.
PED = Infinity = Perfectly Elastic
If PED is infinite only one price can be charged, the demand curve in this case is perfectly horizontal. If a firm increased it's price by 1% all it's demand would be lost. Consider buying carrots at a market, there are many farmers selling their carrots and it's easy to compare prices between farmers. If one farmer raises the price of their carrots consumers will simply go to another farmer.
Determinants of Price Elasticity of Demand
1) Price of good / proportion of income spent on good
2) Availability of Substitutes
3) Time
4) Whether product is luxury or a necessity