Economics

Price Elasticity of Demand (PED)

Definition

Price Elasticity Demand (PED) measures how much the quantity demanded of a good or
service changes in response to a change in its price, while other factors remain

●​ Explanation
○​ Basically, (PED) measures how much people change the amount they buy of
something when its price goes up or down.

Breaking it Down

Price: Refers to the cost of a good or service that consumers pay.

Elasticity: Refers to the responsiveness or sensitivity of demand to changes in price.

●​ If demand changes a lot when the price changes, it is elastic.

●​ If demand changes very little when the price changes, it is inelastic.

Demand: Refers to the quantity of a good or service that consumers are willing and able to
buy at a given price.

Elastic Demand

Definition:Demand is elastic when a small change in price causes a large change in the
quantity demanded.

●​ This happens because consumers are sensitive to price changes

Examples

●​ Imagine the price of a brand of chocolates increases by 20%.As a result, many

people stop buying this chocolate and switch to a cheaper brand.This is elastic
demand because the quantity demanded changed a lot when the price changed.
Inelastic Demand

Definition:When the quantity demanded changes by a smaller percentage than the change
in price.

●​ This means consumers are not very responsive to price changes.

●​ Examples
○​ Think about medicines or salt.
○​ If the price of a life-saving medicine increases by 50%, people will still buy it
because they need it.
○​ This is inelastic demand because the quantity demanded didn’t change much
even when the price increased significantly.

Difference between Elastic & Inelastic Demand

Understanding PED Values

●​ If demand is elastic, the PED number is more than 1 but not infinity.
●​ If demand is inelastic, the PED number is less than 1 but more than 0.
Important Note:

○​ The PED number is usually negative because when price goes up, people
buy less.
○​ But to keep things simple, we treat PED as positive.

Price Elasticity of Demand (CALCULATION)

Question:

A shop offers a product at $60, with 60 units purchased by customers. The shop decides to
raise the price to $105, and as a result, the quantity demanded drops to 45 units.

Calculate the Price Elasticity of Demand (PED) and determine if demand is elastic or
inelastic.

Formula:

PED = (% Change in Quantity Demanded) ÷ (% Change in Price)

Steps for Calculation:

Change in Price

Percentage Change in Price:

((New Price - Old Price) ÷ Old Price) × 100

Calculation:

((105 - 60) ÷ 60) × 100 = 75%

Change in Quantity Demanded

Percentage Change in Quantity:

((Old Quantity - New Quantity) ÷ Old Quantity) × 100

Calculation:

((60 - 45) ÷ 60) × 100 = 33.33%

Price Elasticity of Demand Calculation

PED = 33.33 ÷ 75 = 0.44

Conclusion:

Since the PED value is below 1 (0.44), the demand is inelastic, indicating that the price
increase did not lead to a significant drop in quantity demanded.
Determinants of Price Elasticity of Demand (PED)

Factors:

Availability of Substitutes

Goods with a higher number of substitutes tend to have more elastic demand since
consumers can easily switch to other brands.

Proportion of Income Spent

●​ When a small share of income is used for a product, demand is typically inelastic.
●​ If a larger share of income is spent, demand is usually elastic.

Necessity vs. Luxury

●​ Demand for necessities is inelastic as consumers continue purchasing despite price

changes.
●​ Demand for luxury goods is elastic because people may reduce consumption if
prices rise.

Addictive Nature

If a product is habit-forming (e.g., alcohol, tobacco), demand tends to be inelastic.

Postponement of Purchase

If purchasing a product can be delayed, demand tends to be elastic.

Factors Affecting Price Elasticity of Demand

More specifically categorized products (e.g., a particular brand) generally have more elastic
demand.

Time Period

Over an extended duration, demand becomes more elastic as consumers find alternatives or
modify their consumption patterns.
Perfectly Elastic and Inelastic Demand

Perfectly Elastic

A small price change results in a complete shift in quantity demanded.

The PED value is infinite, and the demand curve is a horizontal line.

●​ Example: A perfectly competitive vegetable market, where any price change will
cause the demand to drop to zero.

Perfectly Inelastic Demand:

A price change has no impact on the quantity demanded.

The PED value is 0, and the demand curve is a vertical line.

●​ Example: Life-saving medications where consumers will buy regardless of price

changes.
Unit Elastic Demand

A change in price causes an equal percentage change in quantity demanded.

●​ The PED value is 1, so total

revenue stays the same when the price
changes.

[Price × Quantity= Total revenue]

PED and Total Revenue

When demand is inelastic, a price change causes total revenue to move in the same
direction.

Example:

If P = $10 and Qd = 50, then TR = P × Q = $500

If P increases to $12 and Qd decreases to 45, then TR = 12 × 45 = $540

Important Notes​

●​ When price rises, total revenue increases.

●​ When price falls, total revenue decreases.

The Effect of an Increase in Demand on PED

The Price Elasticity of Demand (PED) changes when the demand curve shifts. When
demand increases, consumers become less sensitive to price changes, which makes PED
smaller.

PED starts at -5 (50% ÷ 10%). When the price drops from $10, and the demand curve shifts
to D1, PED becomes -2.5 (25% ÷ 10%). PED stays at -2.5 (25% ÷ 10%
This shows that as demand increases, PED becomes less elastic, and people are less
sensitive to price changes.

Interpret the value?

We need to say elastic or inelastic.

Since elasticity is reduced, at D2 that is why it is inelastic.

The Effect of Decrease in Demand on PED

When demand decreases, consumers become more sensitive to price changes, and
demand becomes more elastic. Figure 11.8 shows PED rising from -5 (50% ÷ -10%) to -10
(100% ÷ -10%).

Implications of PED for Decision-Making:

1.​ Consumers benefit from lower prices and better-quality products. When demand is
elastic, substitutes are available, so producers must offer high quality and low prices
because higher prices will greatly reduce demand.
2.​ Producers try to make their products unique to discourage consumers from switching
to other products. This ensures their products are not seen as close substitutes.
3.​ If the government wants to reduce the use of a product, demand needs to be elastic.
To collect more revenue, demand needs to be inelastic.
Key Terms from the Notes on Price Elasticity of Demand (PED)
●​ Price Elasticity of Demand (PED) – Measures how much quantity demanded
changes with price.
●​ Price – The cost consumers pay for a good or service.
●​ Elasticity – The responsiveness of demand to price changes.
●​ Demand – The quantity of a good or service consumers are willing and able to buy.
●​ Types of Demand:
○​ Elastic Demand – A small price change causes a big change in how much
people buy (PED > 1).
○​ Inelastic Demand – A price change causes only a small change in how much
people buy (PED < 1).
○​ Perfectly Elastic Demand – Even a tiny price change makes demand
disappear (PED = infinity).
○​ Perfectly Inelastic Demand – No matter the price, people buy the same
amount (PED = 0).
○​ Unit Elastic Demand – Price and demand change by the same percentage
(PED = 1).
●​ Calculation of PED:
○​ Formula: PED = (% Change in Quantity Demanded) ÷ (% Change in Price).
○​ Percentage Change in Price: ((New Price - Old Price) ÷ Old Price) × 100.
○​ Percentage Change in Quantity Demanded: ((Old Quantity - New Quantity) ÷
Old Quantity) × 100.
●​ Determinants of PED:
○​ Availability of Substitutes – More substitutes make demand elastic.
○​ Proportion of Income Spent – Expensive goods have more elastic demand.
○​ Necessity vs. Luxury – Necessities = inelastic demand; luxuries = elastic
demand.
○​ Addictive Nature – Addictive goods (e.g., tobacco) have inelastic demand.
○​ Postponement of Purchase – If purchase can be delayed, demand is elastic.
○​ Time Period – Demand becomes more elastic over time.
●​ PED and Total Revenue:
○​ Total Revenue (TR) = Price × Quantity Demanded.
○​ When demand is inelastic: Price increase → TR increases.
○​ When demand is elastic: Price increase → TR decreases.

●​ Effect of Demand Shifts on PED:

○​ Increase in Demand: Consumers become less sensitive to price changes →
PED decreases.
○​ Decrease in Demand: Consumers become more sensitive to price changes
→ PED increases.
 ●​ Implications for Decision-Making:
○​ Consumer Benefits: Lower prices and better quality in elastic markets.
○​ Producer Strategy: Make products unique to reduce elasticity.
○​ Government Policy: To reduce product usage → demand should be elastic.
To increase tax revenue → demand should be inelastic.

Price Elasticity of Supply (PES)

Definition

Price Elasticity of Supply (PES) measures how much the quantity supplied changes when
the price changes.

Breaking It Down

Price: The cost of a good or service that consumers pay.

Elasticity: How much supply responds to price changes.

●​ If supply changes a lot when the price changes, it is elastic.

●​ If supply changes very little, it is inelastic.

Supply: The quantity of a good or service that producers are willing and able to sell at a
given price.

Elastic Supply

Definition: Elastic Supply occurs when the quantity supplied changes by a greater
percentage than the change in price. This means that producers can quickly increase the
quantity supplied when the price rises.

●​ This type of supply is represented by a relatively flat curve on a graph, indicating that
supply is highly responsive to price changes.

Example: A car factory can produce more cars if the price increases because it has flexible
production lines and extra workers.

Key Notes:

●​ When the Price Elasticity of Supply (PES) is greater than 1.

●​ Producers can quickly increase supply when the price rises.
●​ Manufactured goods, luxury items, and products with flexible production processes
usually have elastic supply.
Calculation example for elastic supply

Price increases from $10 to $15, and quantity supplied increases from 1,000 to 2,500 units.

Steps for Calculation:PES = (Percentage change in quantity supplied) / (Percentage change

in price)

Percentage change in price: (New Price - Old Price) / Old Price = (15 - 10) / 10 = 50%

Percentage change in quantity supplied: (New Supply - Old Supply) / Old Supply

=(2500 - 1000) / 1000 = 150%

PES: 150% / 50% = 3

Since PES = 3 (PES > 1), supply is elastic.

Inelastic Supply

Definition: Inelastic Supply occurs when the quantity supplied changes by a smaller
percentage than the change in price. This means that producers cannot quickly increase
supply when the price rises.

●​ This type of supply is represented by a steep curve on a graph, indicating that supply
responds very little to price changes.

Example

●​ Fresh vegetables: Farmers cannot quickly grow more even if prices increase.
●​ Oil production: It takes a long time to drill for more oil, so supply does not change
much when price changes.

Key Notes:

●​ When the Price Elasticity of Supply (PES) is greater than 0 but less than 1.
●​ Producers are unable to quickly increase supply when the price rises.
●​ Goods that are typically associated with inelastic supply include natural resources,
fresh food, and goods with fixed supply
Calculation example for inelastic supply

Steps for Calculation:PES = (Percentage change in quantity supplied) / (Percentage change

in price)

PES = (New Supply - Old Supply) / Old Supply ÷ (New Price - Old Price) / Old Price

Example of calculation: Price increases from $20 to $22,Quantity supplied increases from
500 to 520 units.

Percentage change in price: (New Price - Old Price) / Old Price = (22 - 20) / 20 = 10%

Percentage change in quantity supplied: (New Supply - Old Supply) / Old Supply = (520 -
500) / 500 = 4%

PES: PES = 4% / 10% = 0.4

Since PES = 0.4 (PES < 1), supply is inelastic.

Difference Between Elastic & Inelastic Supply

Understanding PES Values

●​ If supply is elastic, the PES value is more than 1.

●​ If supply is inelastic, the PES value is less than 1.

Important Note: The PES number is usually positive because price and supply move in the
same direction.

Determinants of Price Elasticity of Supply (PES)

Availability of Spare Capacity:

●​ If firms have extra resources or idle machines, they can quickly increase production,
resulting in an Elastic Supply.
●​ If firms are already at full capacity, they can’t increase supply easily, leading to an
Inelastic Supply.

Time Period:

●​ Short Run: Supply tends to be Inelastic since firms cannot adjust production
immediately.
●​ Long Run: Supply becomes Elastic as firms have time to adjust production.

Ease of Storing Stock:

●​ Products that are easily stored allow firms to increase supply when prices rise,
making the supply Elastic.
●​ Products that can’t be easily stored, like fresh food, result in an Inelastic Supply, as
firms can’t respond quickly.

Flexibility of Production:

●​ If firms can easily switch between goods, supply is Elastic.

●​ If production requires specialized equipment, the supply is Inelastic.
Perfectly Elastic and Inelastic Supply

Perfectly Elastic Supply

Definition: Perfectly Elastic Supply occurs when a small change in price causes an infinite
change in quantity supplied.

●​ This means that even a slight change in price leads to an enormous change in
supply.
●​ This type of supply is represented by a horizontal line on a graph.

Example: A farmer selling wheat in a competitive market.

Perfectly Inelastic Supply

Definition: Perfectly Inelastic Supply occurs when a change in price has no effect on the
quantity supplied. This means that no matter how much the price changes, the supply
remains the same.

●​ This type of supply is represented by a vertical line on a graph, showing that the
quantity supplied is fixed, regardless of price changes.

Example: A fixed number of seats in a stadium.

Unit Price Elasticity of Supply

Unit Price Elasticity of Supply occurs when a change in price causes an equal percentage
change in the quantity supplied.

●​ It is represented by a straight line passing through the origin, indicating a one-to-one

relationship between price and supply.

Implications of PES for Decision-Making

For Consumers

●​ When supply is elastic, producers can respond quickly, preventing price spikes.
●​ When supply is inelastic, prices may rise significantly if demand increases.

For Producers

●​ If supply is elastic, firms can take advantage of rising prices by increasing production.
●​ If supply is inelastic, firms may struggle to meet demand, leading to lost
opportunities.

For Governments

●​ Governments may encourage supply elasticity by providing subsidies or tax breaks.

●​ If supply is inelastic, shortages can occur, leading to higher prices for consumers.

Key Terms and Major Points for Price Elasticity of Supply

1.​ Price Elasticity of Supply (PES): Measures how much the quantity supplied changes
when the price changes.
○​ If supply changes a lot with price changes: Elastic Supply.
○​ If supply changes little with price changes: Inelastic Supply.
2.​ Elastic Supply:
○​ When the supply changes more than the price change.
○​ Producers can quickly increase supply when prices go up.
○​ Example: Car factory producing more cars with higher prices.
○​ PES > 1.

3.​ Inelastic Supply:

○​ When the supply changes less than the price change.
○​ Producers can’t quickly increase supply when prices rise.
○​ Example: Farmers can’t grow more vegetables quickly.
○​ PES < 1.

4.​ PES Calculation:

○​ Formula: PES = (Percentage change in quantity supplied) / (Percentage
change in price).
○​ Elastic Supply Example: PES = 3.
○​ Inelastic Supply Example: PES = 0.4.

5.​ Determinants of PES:

○​ Spare Capacity: Extra resources make supply elastic, full capacity makes it
inelastic.
○​ Time Period: In the short run, supply is inelastic; in the long run, supply is
elastic.
○​ Ease of Storing Stock: Easy to store = Elastic; hard to store = Inelastic.

6.​ Flexibility of Production: Flexible production = Elastic; specialized production =

Inelastic.

7.​ Perfectly Elastic Supply:

○​ Small price change causes an infinite change in supply.
○​ Represented by a horizontal line.
○​ Example: Wheat in a competitive market.

8.​ Perfectly Inelastic Supply:

○​ No change in supply regardless of price changes.
○​ Represented by a vertical line.
○​ Example: Fixed number of seats in a stadium.
9.​ Unit Price Elasticity of Supply:
○​ Price and supply change by the same percentage.
○​ Represented by a straight line through the origin.

10.​Implications:
○​ For Consumers: Elastic supply helps prevent price spikes; Inelastic supply
causes higher prices.
○​ For Producers: Elastic supply allows for more production; Inelastic supply
may cause lost opportunities.
○​ For Governments: Governments can encourage elasticity with subsidies or
tax breaks to avoid shortages.