Price Elasticity of Demand (PED)

Introduction

Price elasticity of demand (PED) is a measure of how much the quantity demanded of a good or service changes in response to a change in its price. It is a crucial concept in economics as it helps businesses understand consumer responsiveness and make informed pricing decisions. Understanding PED is essential for the IGCSE Economics 0455 exam.

Formula for PED

The PED is calculated using the following formula:

$$PED = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}}$$

Where:

• Percentage Change in Quantity Demanded = $$ \frac{\text{New Quantity} - \text{Old Quantity}}{\text{Old Quantity}} \times 100$$
• Percentage Change in Price = $$ \frac{\text{New Price} - \text{Old Price}}{\text{Old Price}} \times 100$$

Interpreting PED Values

The calculated PED value provides information about the responsiveness of consumers to price changes. Here's a breakdown of common PED categories:

• Elastic Demand (PED > 1): A significant change in quantity demanded occurs with a small change in price. Consumers are very responsive to price changes.
• Inelastic Demand (PED < 1): A small change in quantity demanded occurs with a large change in price. Consumers are not very responsive to price changes.
• Unit Elastic Demand (PED = 1): The percentage change in quantity demanded is equal to the percentage change in price.
• Perfectly Elastic Demand (PED = ∞): Any increase in price will cause demand to fall to zero. This is a theoretical extreme.
• Perfectly Inelastic Demand (PED = 0): Quantity demanded does not change at all, regardless of price changes. This is also a theoretical extreme.

Factors Affecting PED

Several factors influence the PED of a good or service:

• Availability of Substitutes: The more substitutes available, the more elastic the demand. Consumers can easily switch to alternatives if the price increases.
• Necessity vs. Luxury: Necessities (e.g., food, medicine) tend to have inelastic demand, while luxuries (e.g., expensive cars, designer clothes) tend to have elastic demand.
• Proportion of Income Spent: Goods that represent a large proportion of a consumer's income tend to have more elastic demand.
• Time Horizon: Demand tends to become more elastic over longer time periods. Consumers have more time to find substitutes or adjust their consumption habits.

Calculating PED - Example

Suppose the price of a product increased from £10 to £12. As a result, the quantity demanded decreased from 100 units to 80 units.

Using the formula:

$$PED = \frac{\frac{80 - 100}{100}}{\frac{12 - 10}{10}} \times 100$$

$$PED = \frac{\frac{-20}{100}}{\frac{2}{10}} \times 100$$

$$PED = \frac{-0.2}{0.2} \times 100$$

$$PED = -1 \times 100$$

Therefore, the PED is -1. This indicates unit elastic demand.

Table Summary

PED Value	Interpretation
PED > 1	Elastic Demand
PED < 1	Inelastic Demand
PED = 1	Unit Elastic Demand
PED = ∞	Perfectly Elastic Demand
PED = 0	Perfectly Inelastic Demand

Conclusion

Understanding PED is vital for businesses to make informed pricing decisions. By analyzing the PED of their products, businesses can predict how changes in price will affect demand and adjust their pricing strategies accordingly. This helps maximize revenue and profitability.