Price elasticity of demand
Price elasticity of demand
$$\text{PED} = \frac{\%\ \text{change in quantity demanded}}{\%\ \text{change in price}}$$
| Value (size) | Name | Meaning |
|---|---|---|
| > 1 | elastic | quantity responds a lot |
| < 1 | inelastic | quantity responds a little |
| = 1 | unit elastic | same % change |
- More/closer substitutes, luxuries, a big income share, and more time → more elastic. Necessities and habit → inelastic.
Practice
Quantity demanded falls 10% when price rises 5%. What is the size of the PED?
PED size = %ΔQ ÷ %ΔP = 10 ÷ 5 = 2 (elastic).
Practice
Demand tends to be MORE elastic when:
More substitutes, luxuries, a big income share and more time all make demand more elastic.
PED and total revenue
- Total revenue = price × quantity.
| Demand | price rises | price falls |
|---|---|---|
| inelastic | TR rises | TR falls |
| elastic | TR falls | TR rises |
- So a tax on an inelastic good (petrol) raises a lot of revenue without cutting sales much.
Practice
If demand is inelastic and the firm raises its price, total revenue will:
With inelastic demand, quantity barely falls, so a higher price raises total revenue.
You've got it
Key idea
- PED = %ΔQ ÷ %ΔP; >1 elastic, <1 inelastic
- elastic when there are substitutes, it's a luxury, or given time
- inelastic + price up → revenue up (why petrol taxes work)