Drawing and interpretation of demand curve diagrams to show different PED

Resources | Subject Notes | Economics

Price Elasticity of Demand (PED)

Price elasticity of demand (PED) measures how much the quantity demanded of a good changes in response to a change in its price. It's a crucial concept in economics as it helps us understand consumer behavior and how markets respond to price fluctuations.

Understanding PED

PED is calculated as:

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

The value of PED indicates the responsiveness of quantity demanded to a price change. The possible categories of PED are:

  • Elastic Demand: PED > 1 (Significant change in quantity demanded in response to a price change)
  • Inelastic Demand: PED < 1 (Small change in quantity demanded in response to a price change)
  • Unit Elastic Demand: PED = 1 (Proportional change in quantity demanded to the price change)
  • Perfectly Elastic Demand: PED = ∞ (Any price increase leads to zero quantity demanded)
  • Perfectly Inelastic Demand: PED = 0 (Quantity demanded does not change regardless of price changes)

Demand Curve Diagrams and PED

We can use demand curve diagrams to visually represent different PED categories. The shape of the demand curve is the key indicator.

1. Perfectly Elastic Demand

A perfectly elastic demand curve is a horizontal line. This means that consumers will buy any quantity at a specific price, but they will not buy anything if the price is increased even slightly.

Suggested diagram: A perfectly elastic demand curve is a horizontal line. The demand is infinitely elastic at that price point.
Price Quantity Demanded
$P_1$ $Q_1$
$P_2$ $Q_1$
$P_3$ $Q_1$

2. Perfectly Inelastic Demand

A perfectly inelastic demand curve is a vertical line. This means that the quantity demanded does not change regardless of the price. Consumers will buy the same amount at any price.

Suggested diagram: A perfectly inelastic demand curve is a vertical line. The quantity demanded remains constant regardless of the price.
Price Quantity Demanded
$P_1$ $Q_1$
$P_2$ $Q_1$
$P_3$ $Q_1$

3. Unit Elastic Demand

A unit elastic demand curve is a straight line that slopes downwards. The percentage change in quantity demanded is equal to the percentage change in price.

Suggested diagram: A unit elastic demand curve is a straight line sloping downwards. The percentage change in quantity demanded is equal to the percentage change in price.
Price Quantity Demanded
$P_1$ $Q_1$
$P_2$ $Q_2$

4. Elastic Demand

An elastic demand curve is a steeply sloping downward curve. The percentage change in quantity demanded is greater than the percentage change in price.

Suggested diagram: An elastic demand curve is a steeply sloping downward curve. A small change in price leads to a relatively large change in quantity demanded.
Price Quantity Demanded
$P_1$ $Q_1$
$P_2$ $Q_2$

5. Inelastic Demand

An inelastic demand curve is a gently sloping downward curve. The percentage change in quantity demanded is less than the percentage change in price.

Suggested diagram: An inelastic demand curve is a gently sloping downward curve. A change in price leads to a relatively small change in quantity demanded.
Price Quantity Demanded
$P_1$ $Q_1$
$P_2$ $Q_2$

Factors Affecting PED

Several factors influence the price elasticity of demand:

  • Availability of Substitutes: More substitutes lead to more elastic demand.
  • Necessity vs. Luxury: Necessities tend to have inelastic demand.
  • Proportion of Income Spent: Goods that take up a large proportion of income tend to have more elastic demand.
  • Time Horizon: Demand tends to be more elastic over a longer time horizon.

Importance of PED

Understanding PED is important for businesses when making pricing decisions. If demand is elastic, a price increase will lead to a significant decrease in quantity demanded, potentially reducing total revenue. If demand is inelastic, a price increase can lead to an increase in total revenue.