Price Elasticity of Demand (PED) (DP IB Economics)

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

• To calculate a % change, use the following formula

Interpreting PED Values

The size of PED Varies from 0 to Infinity (∞) and is Classified as Follows

Value	Name	Explanation	Diagram
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)

The Determinants of 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 & 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 time period consumers may feel the price increase more and will then look for substitutes resulting in a higher value of PED (relatively elastic)