Price Elasticity of Demand (PED)

From ZuluNotes - Free Leaving Cert Notes

• Price elasticity of demand is defined as ‘The degree of responsiveness of quantity demanded of a good to a change in the price of that good’.

• PED = Proportionate change in quantity demanded, divided by the Proportionate change in price.

• A negative value PED indicates that the good obeys the Law of Demand i.e If P rises, D falls and vice versa.

• A positive value PED indicates that the good does not obey the Law of Demand i.e If P rises, D rises and vice versa (e.g Giffen goods, snob goods and goods affected by consumers' expectations].

• If PED > 1 the good is price elastic. (Change in Q is bigger than change in P)

• If PED < 1 the good is price inelastic. (Change in Q is smaller than change in P)

• If PED = 1 the good is of unit elasticity. (Change in Q equals change in P)

What Determines The PED?

1. Are close substitutes available? A good with many close substitute goods will be price elastic while goods with few close substitutes (or none at all) will be price inelastic.
2. Is the good expensive? A good that is expensive is more likely to be elastic to price change. A cheaper good (newspaper, box of matches) is likely to be inelastic as people can afford the price change.
3. Is the product durable? If a product has a long life consumers will postpone replacing it if prices rise.
4. Habits/brand loyalty by consumers. If consumers are loyal to the product it is likely to be price inelastic.
5. Cheaper of 2 complementary goods? If a good is the cheaper of two complementary goods it’s likely to be inelastic.