Price Elasticity of Demand (PED) Notes

Price Elasticity of Demand (PED)

• Definition: PED measures the responsiveness of the quantity demanded of a good to a change in its price, holding other factors constant (ceteris paribus).

• Formula:
  ext{PED} = \frac{\% \text{change in quantity demanded}}{\% \text{change in price}}

Demand Curve and Its Interpretation

• Demand Curve:

  • A graphical representation of the relationship between the price of a good and the quantity demanded.

  • A shift in price leads to movements along the demand curve rather than shifts of the curve itself.

• Types of PED Values:

  • Elastic Demand (PED > 1): Quantity demanded changes more than proportionately to price changes. Ex: Luxury goods.

  • Inelastic Demand (PED < 1): Quantity demanded changes less than proportionately to price changes. Ex: Necessities like medications.

  • Unitary Elastic Demand (PED = 1): Proportionate change in quantity demanded equals the proportionate change in price.

  • Perfectly Inelastic Demand (PED = 0): Quantity demanded does not change regardless of price changes. Ex: Life-saving medications.

  • Perfectly Elastic Demand (PED = ∞): Any price increase results in zero quantity demanded. Ex: Commodity goods.

Factors Affecting PED

• Availability of Substitutes:

  • More substitutes available => More elastic demand.

  • Fewer substitutes available => More inelastic demand.

• Degree of Necessity:

  • Necessities (e.g., food, medicine) tend to have inelastic demand.

  • Luxuries tend to have elastic demand.

• Addiction:

  • Addictive goods (e.g., cigarettes) typically have inelastic demand due to consumer dependence.

• Proportion of Income:

  • Goods that constitute a larger part of income (e.g., rent) are more elastic. Smaller proportion (e.g., toothpaste) leads to inelastic demand.

• Time Period:

  • In the short run, supply and demand are less elastic; in the long run, they become more elastic as consumers find substitutes.

Calculation of PED Example

1. Initial Situation:
   Price of tickets: $150; Quantity demanded: 25,000
   New Situation:
   Price of tickets: $180; Quantity demanded: 24,000

2. Calculation:

   • % change in quantity demanded:
     = \frac{(24000 - 25000)}{25000} \times 100 = -4 ext{%}

   • % change in price:
     = \frac{(180 - 150)}{150} \times 100 = 20 ext{%}

   • So
     ext{PED} = \frac{-4}{20} = -0.2

   • Interpretation: Demand is inelastic, meaning a 1% increase in price leads to a 0.2% decrease in the quantity demanded.

Relationship Between PED and Total Revenue

• Total Revenue (TR): ext{TR} = ext{Price} \times ext{Quantity} .

  • For elastic demand (PED > 1): Lowering prices can increase total revenue.

  • For inelastic demand (PED < 1): Raising prices can increase total revenue.

Applications of PED in Business and Government

• Pricing Strategy:

  • Elastic Demand: Producers should lower prices to increase total revenue.

  • Inelastic Demand: Producers should increase prices to raise total revenue.

• Government Policy:

  • Usage of taxes (e.g., sugar tax) to decrease quantity demanded of certain goods (cigarettes, sugary drinks).

  • Evaluating subsidy impacts on consumption of essential goods (fruits, vegetables).

Summary Table of PED Values