Price Elasticity of Demand (PED)

Main Influences on Whether Demand is Elastic or Inelastic

Price elasticity of demand (PED) measures how much the quantity demanded of a good changes in response to a change in its price. Understanding the factors that influence PED is crucial in economics.

What is Price Elasticity of Demand?

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:

• Elastic Demand: PED > 1. A significant change in quantity demanded occurs with a small change in price.
• Inelastic Demand: PED < 1. A small change in quantity demanded occurs with a large change in price.
• 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 lead to zero quantity demanded.
• Perfectly Inelastic Demand: PED = 0. No change in quantity demanded occurs regardless of the price change.

Key Influences on PED

Several factors determine whether the demand for a good is elastic or inelastic. These can be broadly categorized as:

1. Availability of Substitutes

1. More Substitutes: Goods with many close substitutes tend to have elastic demand. If the price of one good rises, consumers can easily switch to a substitute.
2. Fewer Substitutes: Goods with few or no close substitutes tend to have inelastic demand. Consumers have limited options if the price increases.

Good	Number of Substitutes	Expected PED
Generic Medicines	Many	Elastic
Essential Medicine (e.g., Insulin)	Few	Inelastic
Coffee	Many (tea, energy drinks)	Elastic
Electricity	Few	Inelastic

2. Necessity vs. Luxury

1. Necessities: Goods considered essential for survival or well-being (e.g., food, medicine) typically have inelastic demand. People will continue to buy them even if the price increases.
2. Luxuries: Goods that are not essential (e.g., expensive cars, designer clothes) tend to have elastic demand. Consumers are more likely to reduce their consumption if the price rises.

3. Proportion of Income Spent on the Good

1. Large Proportion of Income: Goods that represent a significant portion of a consumer's income (e.g., housing, car) tend to have inelastic demand. Consumers are less able to reduce their consumption if the price increases.
2. Small Proportion of Income: Goods that represent a small portion of a consumer's income (e.g., salt, pepper) tend to have elastic demand. Consumers are more likely to switch to alternatives if the price rises.

4. Time Horizon

1. Longer Time Horizon: Demand tends to be more elastic over a longer period. Consumers have more time to find substitutes or adjust their consumption patterns.
2. Shorter Time Horizon: Demand tends to be more inelastic in the short run. Consumers may not have the time to find alternatives quickly.

Summary

The price elasticity of demand is influenced by a combination of factors. Understanding these influences helps businesses make informed decisions about pricing strategies and predict how changes in price will affect their sales.