Price Elasticity of Demand

Understanding Price Elasticity of Demand (PED)

Price Elasticity of Demand Measures the responsiveness of quantity demanded of a good to a change in the price. It is an indicator of how responsive a consumer is to a change in that goods price.

PED is calculated by:

%change in Quantity Demanded (ΔQd)

% Change in Price (ΔP)

PED > 1 = Price Elastic Demand

PED = 1 Unitary Elastic

PED < 1 Price Inelastic Demand

There are a number of factors that can cause consumers to be more or less responsive, such as:

% of Income spent on the good
Degree of Necessity
Time
Closeness of Substitutes

The video will discuss this in more detail and explain how we show the values of PED with the demand curve.

Price Elasticity of Demand Pt1 copy 1.mp4

Relationship between PED and Total Revenue

In order to understand this next video, we need to remember 2 things: the equations, for PED and Total Revenue.

%change in Quantity Demanded (ΔQd)

% Change in Price (ΔP)

As we have seen in video 1, a value of PED>1 (elastic demand) means consumers are more responsive to a change in price (ΔQd>ΔP). Or if PED<1 (inelastic demand) then consumers are less responsive to a change in the price. (ΔQd<ΔP). Finally the PED=1 (Unitary Elastic), then (ΔQd=ΔP).

Total Revenue is the total amount of money a business will make by selling a certain amount of a good at a certain price. It is simply calculated by:

TR = Price per unit x quantity of units sold (p x q)

e.g. A firm sells 100 units at $2. The total revenue =$2 x 100 = $200.

The following video helps us understand 2 key things:

How the PED can vary along the same demand curve.
How understanding this can help firms understand that their revenue will be maximised at the point where PED=1.

For example, when PED>1, then ΔQd>ΔP. This means the % quantity demanded increase will be more than % decrease in the Price, therefore Total Revenue will rise. On the other hand, when PED<1, ΔQd<ΔP, therefore Total Revenue will decrease.

Price Elasticity of Demand pt2.mp4

Price Elasticity of Demand Pt3.mp4

Application of PED

Now that you understand how to interpret the PED values and what determines a goods PED, we need to look at the applications of this. This final video will discuss how understanding the PED for primary commodities (PED<1) v manufactured goods or services (PED>1) can help us understand the impacts for producers of these goods and the overall impacts on economic activity.

This is particularly important for when we discuss why economies based around primary commodities tend to develop slower than those based around manufacturing.

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