IBEconomicsDPSLRevision Notes2. Microeconomics2.4 Price Elasticity of Demand (PED)Definition, Calculation & Determinants of PED

Definition, Calculation & Determinants of PED (DP IB Economics)

Revision Note

Steve Vorster
DP Economics: SLDP Economics: HL

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 =  end text fraction numerator percent sign space change space in space quantity space demanded over denominator percent sign space change space in space price end fraction space equals space fraction numerator percent sign triangle space in thin space QD over denominator percent sign triangle in space straight P end fraction 

  • To calculate a % change, use the following formula

percent sign space Change space equals space fraction numerator new space value space minus space old space value over denominator old space value end fraction space cross times space 100

Worked Example

A firm raises the price of its products from $10 to $15. Its sales fall from 100 to 40 units per day. Calculate the PED of its products

[2 marks]

Answer:

Step 1:  Calculate the % change in QD

  percent sign triangle QD space equals space fraction numerator 40 minus 100 over denominator 100 end fraction space cross times 100 percent sign triangle QD space equals space minus 60 percent sign 


Step 2: Calculate the % change in P

percent sign triangle straight P space equals space fraction numerator 15 space minus space 10 over denominator 10 end fraction space straight x space 100 percent sign triangle straight P space equals space 50 percent sign


Step 3: Insert the above values in the PED formula

PED space equals space fraction numerator percent sign triangle space in thin space QD over denominator percent sign triangle in space straight P end fraction PED space equals space fraction numerator negative space 60 over denominator space space space space 50 end fraction PED space equals space minus 1.2  

Step 4: Final answer = 1.2

  
The PED value will always be negative so economists ignore the sign and present the answer as 1.2

(Two marks for the correct answer or 1 mark for any correct working in the process)

Examiner Tip

In Paper 2 you are occasionally given the PED value and the %Δ in QD - you are then asked to calculate the %Δ in price. Follow the standard math procedure as follows:

1. Substitute the values provided into the equation

2. Substitute X for %Δ in price

3. Solve for X

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)


2-7-1-calculation-and-determination-of-ped--perfectly-inelastic

0→1

Relatively Inelastic

  • The %∆ in QD is less than proportional to the %∆ in P (e.g. addictive products)


2-7-1-calculation-and-determination-of-ped--relatively-inelastic

1

Unitary Elasticity

  • The % ∆ in QD is exactly equal to the %∆ in P


2-7-1-calculation-and-determination-of-ped---unitary-elasticity

1→ ∞

Relatively Elastic

  • The %∆ in QD is more than proportional to the %∆ in P (e.g. luxury products)


2-7-1-calculation-and-determination-of-ped---relatively-elastic


∞

Perfectly Elastic

  • The %∆ in QD will fall to zero with any %∆ in P (highly theoretical elasticity)


2-7-1-calculation-and-determination-of-ped---perfectly-elastic


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)

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