What price elasticity of demand measures
Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its price. It compares the percentage change in quantity demanded with the percentage change in price that caused it.
Key idea
PED = percentage change in quantity demanded / percentage change in price. Because demand curves slope downward, the value is usually negative, but we normally quote the size (the number) and ignore the sign.
Reading the value
If PED is greater than 1 (ignoring the sign), demand is price elastic: quantity changes by a larger percentage than price. If PED is between 0 and 1, demand is price inelastic: quantity changes by a smaller percentage than price. A value of exactly 1 is unit elastic.
Example
A cinema raises its ticket price by 10 per cent and quantity demanded falls by 25 per cent. PED = 25 / 10 = 2.5, so demand is price elastic and total revenue falls.
What determines PED
- Substitutes: the more close substitutes a good has, the more elastic demand is.
- Proportion of income: goods that take up a large share of income tend to have more elastic demand.
- Necessity or luxury: necessities tend to be inelastic; luxuries tend to be elastic.
- Time: demand is usually more elastic over a longer period, as buyers can adjust their habits.
Remember
- Elastic demand and a price rise mean total revenue falls.
- Inelastic demand and a price rise mean total revenue rises.
- Firms use PED to plan pricing and governments use it to plan indirect taxes.