PRICE

ELASTICITY
OF DEMAND
(Ped)
Short notes for economics
 PRICE ELASTICITY OF DEMAND (PED)
Definitions of PED
PED is the responsiveness of demand for a good or service to
a change in its price.

Calculating PED
PED is calculated using the following formula:

This is often abbreviated as:

Example:
A railway company reduces rail fares from $10 to 9. Daily
demand for tickets rises from 200 to 240. Calculate PED.
Ignoring minus (−) sign.

This gives PED = 2

Interpreting PED (types of ped)
 Elastic demand
This is when the percentage change in quantity is greater
than the percentage change in price. PED is greater than 1.

 Inelastic demand
This is when demand changes by a smaller percentage than
the change in price. PED is less than 1 but greater than 0.

 Unitary
This is when the percentage change in price leads to the
same percentage change in quantity demanded. PED=1
 Perfectly elastic demand
This occurs when there is no change in price but quantity
demanded changes. PED=∞

 Perfectly inelastic demand

occurs when a change in price has no effect on demand. The
value of PED = 0.

Factors influencing PED

1. The number of substitutes
Large number of substitutes – Elastic demand
Small number of substitutes – Inelastic demand
2. Proportion of income
High Proportion – Elastic demand
Low Proportion – Inelastic demand
3. Necessity or luxury product
Luxury product – Elastic demand
Necessity product – Inelastic demand

4. Time period
Long run – Elastic demand
Short run – Inelastic demand

5. Postponement of consumption
Postponement in purchase and consumption - elastic
No postonment in purchase and consumption - inelastic

PED and total revenue

There is a relationship between PED and total spending and
total revenue gained.

 If demand is elastic, a rise in price will cause a fall in

revenue because the quantity demanded will fall by more
than the rise in price in percentage terms.

 If demand is inelastic, a rise in price will cause a rise in

revenue because the quantity demanded will fall by less
than the rise in price in percentage terms.

 If demand is unitary, a rise in price will leave total

revenue unchanged as the proportionate change in
quantity demanded and price will be the same.
Significance of PED for decision making
 To consumers
If demand is elastic, consumers are more likely to benefit
from lower price and higher quality because producers
would be reluctant to raise price as demand would contract
by a greater percentage and revenue would fall.

 To producers
If PED is elastic, a price reduction will increase revenue
because demand will rise by more than price. If PED is
inelastic, a price rise will increase revenue. This is because
demand will fall by less than price.

 To the government
1. Knowledge of PED would help a government estimate how
much tax revenue it may earn from indirect taxes.

2. Knowledge of PED may help a government to estimate

how much of a subsidy to give.

3. Knowledge of PED may influence the price the

government charges for the products it supplies.