2.2 Elasticities (PED)

What is elasticity?

Elasticity is a measure of the responsiveness of one variable to changes in another variable.

What is price elasticity of demand (PED)?

PED measures the responsiveness of quantity demanded of a good to changes in its price.

What is the PED formula?

PED = percentage change in quantity demanded ÷ percentage change in price.

Why is PED normally negative?

Because price and quantity demanded generally move in opposite directions according to the law of demand.

How is PED usually interpreted in IB Economics?

The absolute value of PED is commonly used when describing whether demand is elastic or inelastic.

What does PED > 1 mean?

Demand is price elastic: quantity demanded changes proportionately more than price.

What does PED < 1 mean?

Demand is price inelastic: quantity demanded changes proportionately less than price.

What does PED = 1 mean?

Demand is unit elastic: quantity demanded changes proportionately by the same percentage as price.

What is perfectly inelastic demand?

Perfectly inelastic demand has PED = 0; quantity demanded does not respond to price changes.

What is perfectly elastic demand?

Perfectly elastic demand has an infinitely large PED; consumers will demand any quantity at one particular price but none at a higher price.

What is relatively elastic demand?

Relatively elastic demand has PED greater than 1 in absolute value.

What is relatively inelastic demand?

Relatively inelastic demand has PED less than 1 in absolute value.

What determines PED?

Availability of substitutes, proportion of income spent on the good, whether the good is a necessity or luxury, time period and the definition of the market.

How does availability of substitutes affect PED?

The greater the availability of close substitutes, the more price elastic demand tends to be.

How does the proportion of income spent affect PED?

Goods taking a large proportion of income tend to have more price elastic demand.

How does necessity versus luxury affect PED?

Necessities tend to have more price inelastic demand, while luxuries tend to have more price elastic demand.

How does time affect PED?

Demand tends to become more price elastic over a longer period because consumers have more time to adjust their behaviour and find substitutes.

What is total revenue?

Total revenue is the amount received by firms from sales and is calculated as price × quantity sold.

What happens to total revenue when price rises and demand is elastic?

Total revenue decreases because the percentage fall in quantity demanded is greater than the percentage rise in price.

What happens to total revenue when price rises and demand is inelastic?

Total revenue increases because the percentage fall in quantity demanded is smaller than the percentage rise in price.

What happens to total revenue when price falls and demand is elastic?

Total revenue increases.

What happens to total revenue when price falls and demand is inelastic?

Total revenue decreases.

What happens to total revenue when demand is unit elastic and price changes?

Total revenue remains unchanged.

Why is PED important to firms?

Firms can use PED to anticipate how changes in price may affect quantity demanded and total revenue.

Why is PED important to governments?

Governments can use PED to anticipate the effects of taxes on quantity demanded and tax revenue.