Price Elasticity of Demand

Price elasticity of demand = PED

What is price elasticity of demand?
It is the responsiveness/sensitivity of demand to a change in price.

 

How do economists calculate price elasticity of demand?
PED = % Change in Quantity Demanded
              —————————————–
                       % Change in Price

 

How do we interpret price elasticity of demand values?
Price elasticity of demand values are always negative because the show that price and demand have an inverse relationship.

 

If PED is < -1 :
If PED is smaller than minus one then this implies that the demand is elastic.  For example, if the price of a good rose by 10% the quantity demanded  would decrease by more than 10%. Airline tickets are a good example because they are elastic.

 

If PED is between 0 and -1 :
This means that the demand is inelastic. For example if the price of a good increased by 10% then the quantity demand would decrease by less then 10%. A good example of this is food as they have relatively inelastic demand.

 

If PED = -1 :

Then this means the demand is unitary elastic. This is the rarest out of all the elasticities. It means that if a price of the good rises by 10% the quantity demanded will decrease by 10%
To understand the graphical representation of PED, please see my post on the three types of elasticities.

Test yourself (Answers found at the bottom)

 

1. If price increases from 10 to 12 pence and the price elasticity of demand is -0.5. The quantity demanded was 500 units. What will it be now?
a) 550 units
b) 500 units
c) 450 units
d) 490 units
2.If price elasticity of demand is unit then a fall in price:
a) Reduces revenues
b) Increases revenues
c)Leaves revenues unchanged
d) Reduces costs

 

ANSWERS!

 

1. c) This means that any given percentage fall in price leads to an increase in quantity demanded that is half as much; a 20% price increase will reduce the quantity demanded by 10%. This means the  quantity demanded will be 450 units.
2. c) This means the percentage change in quantity demanded equals the percentage change in price so price changes will not alter the revenue.

A great video to help you with this: http://www.youtube.com/watch?v=4oj_lnj6pXA&feature=related 

Also why not check out some further notes in pdf style (not I have not created this file) : http://www.osc-ib.com/ib-revision-guides/pdf/economics-hl-1.pdf

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